China Redux

On Wednesday, Treasury Secretary Henry Paulson said in a hearing before the Senate Banking Comittee that the Bush administration would continue to pressure China to change its currency policy in hopes of easing the ballooning US trade deficit.  Critics of China’s currency policy believe that the Chinese yuan is undervalued against the U.S dollar by as much as 20%, which increases the US trade deficit by making Chinese goods relatively cheaper.  Paulson, a former chief executive of Goldman Sachs, argued that currency reform would benefit China as well as the United States:

China does not yet have the currency policy that we want it to have and that it needs. The international community will run out of patience with China unless the pace of its reform accelerates.

In spite of the tough talk, much of it undoubtedly for the benefit of the newly empowered Democratic legislators, China is sitting in the catbird seat on this issue.  The reason is that currency reform will benefit the US much more than it will China.  For China, the potential negative effects of an appreciating yuan are far worse than the status quo.  And the US and the international community have little leverage to force China into speeding up the process, beyond the limited measures available to a somewhat indifferent International Finance Corporation (IFC).

The Bush administration is not likely to support sanctions against China.  And China has already taken action in an effort to allay US concerns; in 2005, China began allowing the yuan to float against a basket of currencies rather than keeping it tied to a fixed value against the dollar.   Since then the yuan has risen in value by 6.5% against the dollar.  But critics contend it’s been too little, too late.

So what’s to be done in a stalemate such as this? Not much, probably, but the issue of China’s currency — and the related issue of US trade relations with China and other emerging economies — is shaping up to be a major differentiator in the 2008 presidential election.  And economic populism is getting a serious hearing as political platforms begin to emerge.

Leading the charge at today’s hearing was Senate Banking Commitee Chairman and presidential candidate Christopher Dodd (D-Conn), who said that “more than 3 million manufacturing jobs have been lost since 2001, the steepest and most prolonged job loss since the Great Depression.” That’s one way to tell a complicated story.  If it were that one-sided, the US would be in the midst of another depression instead of solid growth and low unemployment. It’s a somewhat uncomfortable part for Dodd to play: chairman of the Banking Committee in one of the wealthiest states in the country (CT), he needs to raise millions from the financial community over the next 18 months to have any chance of competing in the Democratic primaries.  But he also needs to curry favor with the wing of the party that is suspicious of trade.

Then there’s the contingent that supports imposing penalty tariffs of 27.5% on all Chinese imports unless China revalues its currency, a gropu led by Senator Charles Schumer (D-N.Y.). This draconian measure would likely bring about swift recriminations from the voting public, who would be forced to pay considerably higher prices for basic consumer goods and electronics.

More likely is that the issue of currency reform in China will go nowhere until China decides its economy is able to comfortably sustain any appreciation of the yuan’s value against dollar.  For the most part, that’s probably not such a bad thing for the US economy.   I’ll look at reasons why in a later post.