Wednesday, October 5, 2011

Currency Manipulation and the Wrong Super Hero

This week our US Senate is taking up the issue of China’s currency manipulation. It appears that we have an almost bi-partisan attempt to create even dumber international trade policy. The stock market hasn’t fallen enough – so our Senate has decided it can do even more to impoverish Americans. Way to go Reid! The Republicans who normally wouldn’t go along with this kind of stupidity (since they have their own kind of stupidity) seem to be worried that they need to play this populist card too.  Let’s blame everything on China. China– you bad. US Congress – we good.  So much for intelligent representation and policy!

What do these guys want to do? While the exact legislation is changing each day, the basic idea is that China depreciates its currency to create a competitive advantage for its exports. So we have legislation that would ask someone to calculate the degree of advantage China gets from currency manipulation and that would be fed into a Robot that would spit out the size of a tariff to apply to some or all of China’s imports into America. Sounds easy, right? Sounds fair, right? Sounds like it will save American jobs, right? Sounds like it will make 65 year old men more potent and attractive, right?

This reminds me of that cold day back in the 1970s when a car-full of Indiana University economists slid off a snowy highway between Terre Haute and Indianapolis and found themselves in a ditch wishing that a truck driver would stop and help them. We had a lot of PhDs in that car but no one who actually could figure out which end of the car to push. Luckily a truck driver did stop and offered some advice. He suggested that we push the car down further into the ditch and then floor it enough to drive out of the ditch. We concluded that this particular truck driver must have gotten his license from Purdue University and that there was no way in H___ that we were going to push the car down further into the ditch.  That was really stupid advice and even a bunch of professors knew it. We convinced the brawny driver to help us push the car upward and we were soon out of the ditch and on our way to Indianapolis. 

The point is that sometimes you really want to be rescued but sometimes you get a super-hero who just isn’t up for the task. In the case of China we in America feel threatened. We worry about China taking away our jobs and companies. So it is not wrong that we worry about how to better compete with China.  But this idea to tie US import tariffs to an estimate of Chinese currency manipulation is impossible to implement, will not increase US jobs and competitiveness, and will more than likely than not be counter-productive.

First, it is impossible to do. While we may have lots of theoretical models that might tell us how much China’s currency is under-valued, there are so many different ways to calculate this number that even a robot named Curly-Larry & Moe might sputter around in endless loops of break dancing. Then there is the small issue that implementing increased tariffs based on this number is not only novel but is illegal within the rules of the WTO. There is no precedent for this. While it sounds like a desirable thing to treat currency manipulation as a trade barrier worthy of reacting against, the WTO has not sanctioned this kind of retaliation. 

Then there is the question of other countries that routinely depreciate against the dollar to gain competitive advantage. Would it be proper and fair to only single out the Chinese? So are we really going to work Curly, Larry & Moe overtime on Brazil, and the others too? Do we really want to risk a global trade war right now?  In short it is really hard to find any way to actually implement this policy. It’s like making it illegal for Martians to own homes in Nevada. It sounds good to try to keep them out of Nevada – but I am not sure we have a good way to do this.

Second, this policy is not going to work. Notice that over the last years the Chinese currency has appreciated against the dollar. While it might have appreciated somewhat more, it is not the case that Chinese policy has been to reduce the value of yuan.  Other developing countries have done more.  Note also that these increases in the value of the yuan have not worked to reduce the US-China trade imbalance. So why would more work?

The answer is that it won’t work and it is because there are more fundamental factors at work causing the US to have a large trade deficit with China. Simply put, we in the USA make Miss Piggy look anorexic. We don’t save. We consume. The trade deficit is an expression of this imbalance. We buy from China and what we don’t buy from China we buy from other countries to meet our ever growing appetite for goods. If somehow we reduced our trade deficit with China, the spending would show up as a deficit with another country or countries. Of course China has a similar but opposite imbalance – they consume less and save more. This is perfect for us. We want to buy and they want to sell. Currency manipulation has very little to do with this. The problem is saving/spending and not currency values.  Altering fundamental attitudes and habits with respect to saving and spending is not something that can be done easily or quickly. Thus, our politicians would rather grasp at populist policies that do not work instead of doing the hard work of focusing on the real problems and solutions.

Finally is the recognition that it is counterproductive to focus our policy so strongly on currency manipulation and trade protection. Rome is burning and we throw gasoline on the fire. If this legislation were actually to be passed and signed by president Obama, we would not only be not addressing the real problems but we would be inflaming China and other countries. They know about our imbalances and they fully recognize protectionism when they see it. Other countries will not sit around and wait for us to focus on them next. Other countries are experiencing the continuing painful global slowdown and there is much populist demand for more protectionism in countries all over the world. 

Of course China has plenty of weapons beyond a simple trade war. How will we have served our own interests when China reacts by buying fewer US government bonds as the US government is trying to sell another $1.5 trillion of them? Or what happens if China aggressively sells the government bonds it already holds. W should not stir up trouble if there is nothing to gain. We should not stir up trouble if there is so much to lose! Instead, we should be the leader. We should be the leader for the right policies. We should not be the leader of a downward spiral of devastating protectionism.  If there are any real leaders in Congress we can only hope they will quickly step forward and put a quick end to this very harmful legislation.  


  1. A bit dated, but still applicable:

    Those who ignore history are bound to repeat it...or something like that.

  2. As a manufacturer who has direct experience with China I have opinions on both sides of the track. First, although China needed my products they attempted to force me to manufacture them there...I presume so they could "acquire” the patented formulations. To force me into this, they said they would no longer buy from us because out price was too high. I left it there and no longer sell to them. Since that decision, I keep an automatic Yuan (RNB) to Dollar calculator on my Google Page and the ratio of Yuan to dollar never changes.

    Next: We...managed to dodge the inflation bullet by buy our stuff (needed and unneeded) from China for the past 15 years. Yahoo! more stuff. We (US citizens) were so spendy that we did not look around and see the disappearing jobs or think about the Chinese (US Bonds) funded wars or the excessive use of credit to buy all of this stuff and the ramifications later down the pike. The housing dump was just a symptom of our real problems.

    Lastly; I make this statement strongly!!! We can no longer allow our leadership to be mostly guided by the need to keep their job and the forces (lobbyist) who keep them there. This does not make for good decision making nor does it really fix the problems.

    Steve Jobs died and he epitomized the American business spirit and ushered us into the age where digital equipment can be effectively used. The downside to that is most people take it for granted and have lost the critical thinking skills necessary to make sound decisions and to call BS BS.

  3. Al -- I agree. A quality article that everyone should read. Thanks for posting.

  4. James, It is always nice to get a perspective from people who are directly involved with trade with China. It is interesting to me that some of the luster on China is beginning to wear thin. I seem more articles about re-sourcing. Apparently the US is competing better with China while Chinese labor costs are rising at 15-20% per year. This game is definitely not over. While re-sourcing is not a big trend it definitely bears watching.

  5. Charles had trouble posting -- he asked me to post the following:

    Mr. LSD. I am somewhat encouraged by – at least ABC’s coverage of “Made In ‘merica” – that says some companies are repatriating operations . . . mostly/allegedly from China. If ‘mericans decided to buy ‘merican and not Chinese the need for tariffs would diminish; I like that proposition better. I agree the tariff proposition is a solution to the wrong problem.

  6. Charles and Jim,

    I sometimes get off-line comments from business friends. Recently I heard from the President of a Life Sciences Company who made the point that his successful company is able to keep ahead of foreign competition through continuous quality improvement and innovation. He thinks that our comparative advantage in the US is innovation and that Asian and other competitors are often one step behind. It makes business tough but it sounded pretty optimistic too me. The US is NOT out of the manufacturing picture. We just need to have a business environment and culture that reward innovation!

  7. Interesting take from just a "few" years ago:

  8. Thanks for sharing Al -- that article is a classic defense of free trade. It should be required reading for all college students!


    Perhaps somebody's finally getting it.

  10. Those same dissenters have been dissenting a long time. The bigger question is whether or not Bernanke gets it.