My Life and Times

Great Wall Of China

EDITORIAL
Blame China?

Members of Congress, egged on by American manufacturers, are threatening to slap punitive tariffs on Chinese goods unless China increases the exchange rate of its currency, the yuan, thus raising the price of Chinese imports here. Some Senate Democrats are even threatening to block President Bush's choice for the United States trade representative, Rob Portman, unless the administration also espouses get-tough tactics. This is protectionism raising its ugly head, and an all-around dreadful strategy. That's only in part because Mr. Portman, one of the president's better nominations, deserves confirmation. Worse, it's based on a misunderstanding of both China's financial situation and the cause of American economic woes.

At the heart of this debate is China's policy of linking the value of the yuan to the value of the dollar. That was called sound policy when the dollar was strong. But now that it is weak, Congressional critics call it manipulation because it makes already inexpensive Chinese goods even cheaper the world over. As proof that the yuan is undervalued, the tariff seekers point to the United States' ballooning trade deficit with China, which accounted for about one-fourth of the United States' gargantuan global trade imbalance of $617 billion in 2004.

The trade deficit and the loss of American manufacturing jobs are very serious problems. It would be nice to think that they would self-correct if China would only change its ways. Nice, but wrong. Most of the trade gap with China is caused by Americans' insatiable appetite for Chinese imports, for which there are few domestic substitutes. And even if the yuan's exchange rate is too low - a point on which economists differ - it is a minor contributor to the trade deficit. If China let the yuan appreciate by 20 percent, and most other Asian currencies followed suit, the deficit would probably decline by only about one-fifth over the next year or two. That's not nearly enough to bring the American trade imbalance into a range that is generally considered sustainable.

Tariff-mongering politicians don't necessarily want to believe this. "Many of us feel they're playing this country for a fool," Senator Charles Schumer of New York fumed at a recent hearing. Treasury Secretary John Snow, to his credit, explained at that hearing how a premature yuan revaluation might do more harm than good.

Pegging a currency to the dollar is perfectly legitimate for a country like China with a fragile banking system and rudimentary capital markets. China's problem is that its underdeveloped finance sector exists hand in hand with a surging economy, which puts pressure on the yuan to appreciate. That state of affairs has attracted huge amounts of speculative capital into China, in anticipation that its government will soon allow the yuan to rise. Such speculative capital is destabilizing - feeding, for example, a worrisome Chinese real estate bubble.

This helps explain why China's leaders are so nervous about letting the yuan appreciate. They need a more flexible currency, sooner rather than later, both for the sake of trade relations and to gain more control over their own economy. But if China makes a small currency adjustment, the speculators will be rewarded and will pour in more money in expectation of future upward moves, further destabilizing the economy. And if China makes a large adjustment, it will incur sharp losses in its huge dollar holdings because an upward move in the yuan means a downward move in the dollar. That would only weaken its financial sector.

It's not in China's interest, or in the interest of global economic stability, for China to move the yuan before its officials have coalesced around a strategy for doing so. And American lawmakers should be thinking twice about what the impact at home could be if the yuan is revalued. America's lack of savings - by the government and individuals - is the biggest contributor to global imbalances, making it necessary to "import" billions of dollars of foreign capital daily to cover our budget and trade deficits.

China is America's second-most-important lender, after Japan, and it will become even more important if other Asian nations curb their lending, as they have recently indicated they may. As long as China links the yuan to the dollar, it needs to buy large quantities of United States securities to prop up the dollar, a process that has helped keep American interest rates down and economic growth up.

If China loosened its currency's peg to the dollar, or removed it altogether, it wouldn't need to buy up dollar-based assets at its current torrid pace. The result could be a rise, even a sharp rise, in United States interest rates and, as a corollary, a falloff in economic growth. Neoprotectionist members of Congress should be careful about what they ask for.



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