Be Careful What You Ask For: Yuan Edition

The US has spent considerable time and energy hectoring the Chinese about the artificially low value of its currency (although there is considerable disagreement among experts as to how undervalued it really is). The notion that the currency is the chief culprit has become so fixed in the public imagination that Congress is determined to make some sort of shot across China’s bow, after the US Treasury refused to brand the country a currency manipulator. From Bloomberg:

The U.S. Congress will pass a measure to prod China to raise the value of its currency after the U.S. Treasury’s refusal to label the export powerhouse a currency manipulator, House Speaker Nancy Pelosi predicted.

Pelosi, a California Democrat, said today that she has been warning about the U.S. trade deficit with China for the last 17 years and now the impact on U.S. manufacturers from the weak yuan is attracting the attention of her colleagues…..

The problem is that seeing currency revaluation as the solution is a naive reading of the problem. The US has lost so much manufacturing, either via having multinationals move it offshore, or through the closure of domestic firms, that even a radical revaluation wouldn’t have a very large impact. Are we going to revive, say, shoe and textile manufacture in the US? Highly unlikely.

An excellent post in Econbrowser gives a fuller treatment, and stresses a couple of key points, namely that oil dependence is a much bigger cause of our trade deficit than China, and a stronger yuan will mean higher US interest rates:

As expected, the Treasury declined to declare China a currency manipulator. On the same day, four senators submitted legislation to tie Treasury’s hands in terms of the actions it can take against countries with “misaligned” currencies.

From WSJ:

Bill Would Punish China For Failure to Boost Yuan


June 14, 2007

WASHINGTON — A bipartisan group of senators unveiled a widely anticipated bill that targets Beijing’s currency policy, but critics questioned how effective this and other such anti-China legislation would be.

The bill would require the Treasury Department to take specific action against countries that purposefully “misalign” their currencies, such as cutting off funding to the countries or filing complaints through the World Trade Organization. The bill also would give Congress more oversight of Treasury’s role in the process….

The measure introduced yesterday is co-sponsored by two of China’s biggest congressional critics, Mr. Schumer and Lindsey Graham (R., S.C.), and two lawmakers better known as free traders, Senate Finance Committee Chairman Max Baucus (D., Mont.) and Sen. Charles Grassley of Iowa, the panel’s top-ranking Republican.

The four senators represent a wide spectrum of political thought on trade and their cooperation underscores the depth of unease with China in Congress.

The bill has a good chance of passage given the stature of its backers, who are known in the Senate as experts on trade law, and given the eagerness of lawmakers to pass some kind of legislation addressing the China issue, said Skip Hartquist, counsel to the China Currency Coalition, which represents groups in manufacturing and agriculture. Another plus, he said, is the way in which the bill defines currency manipulation as a trade issue, rather than a monetary one….

The U.S. Trade Representative’s office yesterday said that it was rejecting a petition to take China’s alleged misalignment of its currency as a complaint to the WTO. Such a complaint would be similar to any that might be proposed under the legislation.

The bill also includes language that could shield other countries with arguably undervalued currencies, such as Japan, from being hit with punitive action. The bill says a country can be exempt if it takes “effective remedies” or if the president issues a waiver….

In previous posts, I’ve noted the difficulty in determining whether a currency is misaligned ([1], [2]) so I won’t repeat those arguments here. Despite the difficulty in establishing misalignment, I do think it’s in China’s own best interests to allow a faster currency appreciation — as opposed to the current policy trying to rein in the economy by tighter monetary and administrative policies. That’s because tighter monetary policy merely exacerbates capital inflows, reduces demand and hence imports, thus increasing the balance of payments surplus (this can be shown in a straightforward fashion in a Mundell-Fleming model, as shown here). Clearly the ongoing rapid accumulation of forex reserves is complicating the management of the Chinese macroeconomy. And, of course, more rapid appreciation will aid in the process of global rebalancing [3].

On the other hand, Americans should not delude themselves that a more rapid realignment of the yuan will drastically alter the US current account and trade deficit. This is a point all too easily forgotten in the debate. First substantial expenditure switching will occur only if the rest of the East Asian currencies follow China’s lead. For instance, Marquez and Schindler (forthcoming, Review of International Economics; working paper version here [pdf]) find that a 10% appreciation will result in only a $63 to $70 billion reduction in aggregate Chinese trade balance (and only part of this will go to reducing the United States’ 2007Q1 $727 billion trade deficit (SAAR)). Second, a lot of our trade deficit has to do with oil; changing reliance upon oil requires much tougher choices — see here — than almost any politician has recommended.

Finally, in my view the most important effect of faster yuan appreciation (along with the other East Asian currencies) might be related to diminished purchases of dollar assets, including Treasuries. Less demand for Treasuries, holding all else constant, results in a lower prices (higher yields). Given what we’ve seen this week, I think a lot of people should re-think exactly how fast and discretely they want this adjustment process to proceed.

Print Friendly, PDF & Email