The Chinese-American Currency Wars of 2007-2010

This is the end, my capitalist friend.

The end of the long-standing United States policy of nonintervention in the currency markets.

America has declared war on the Chinese yuan. Depending on whether you go with the House or Senate figures, the yuan is undervalued by anywhere from 15% to more than 40%. That’s a pretty big spread. You’d think they would shore up that minor detail first before proceeding…

Instead, full of rhetoric, bolstered by the cries of the AFL-CIO, Congress put forth two Senate bills this summer, paving a new path to combat “currency manipulators.” Read: China, make your yuan appreciate faster.

The Senate Finance Committee gave its gung-ho approval of 20-1 on July 27. On Aug. 2, the Banking Committee seconded that with a hearty 17-4 in favor of a similar measure.

In a nutshell, Congress wants a stricter definition of currency manipulation. Then, it wants to be able to “punish” the manipulator with anti-dumping tariffs until it changes its tune. That’s the goal of the Fair Currency Act of 2007.

But this currency war is another war we’re unlikely to win.

You see, the earliest we could win this one is 2010. That’s how long it will take to get all the ducks in a row: the International Monetary Fund, the World Trade Organization, and the rest of the world.

By that time, we’ll have a new president. And a lot of manufacturing jobs will already have vanished. And in fact, if we do absolutely nothing and the yuan appreciates just 5% a year, we’ll already be up to 25% appreciation by 2010. So why all the bluster?

Maybe we should give Bush & Co. some credit. Here’s one conflict they’re willing to “talk out.”

Instead of legislation, the IMF, or the WTO, they’re putting the burden on Treasury Secretary Hank Paulson’s “strategic dialogue.” So far, that’s yielded a big fat “NO” from the People’s Bank of China about the yuan. But they did add a few airline routes and cut some export tax rebates.

And they promise more talk. Hank Paulson is forced to make America a two-faced Janus god of currency. Paulson “urges the Chinese President Hu Jintao and Vice Premier Wu Yi to allow the yuan to rise more quickly, arguing it would boost China’s stability and modernization.” Essentially, that’s like telling Bush to tell Bernanke what to do. And of course, it’s not as if Paulson gets to paint the U.S. as the poster child of stability and modernization, else we’d not be having this “strategic dialogue” in the first place.

But that’s not his concern… Hank is too busy telling China how he and President Bush are NOT behind the Congressional push to penalize China for its yuan management.

Surely, we should not expect China to take seriously this “house divided” method of currency critique. And just how long has this tomfoolery been going on?”

Shot off the Bow: the China Currency Coalition

Back before July 2005, the yuan was pegged to the dollar. In steps a business interest group called the China Currency Coalition. These concerned denizens of the trade union world filed a petition with the U.S. Treasury representative demanding an investigation of China. According to member and secretary-treasurer of the AFL-CIO Richard Trumka, here’s what happened:

“The Bush administration summarily rejected the petition within a few hours of its filing — apparently without taking the time to read the several hundred pages of analysis, documentation, statistics, and tables.”

Similar petitions were filed by Congress — and rejected.

Trumka goes on to say: “This administration makes me feel like Bill Murray in the movie Groundhog Day. We show how the Chinese government manipulates their currency. Over and over, they send back a procession of Treasury secretaries, undersecretaries, deputy secretaries, and the USTR to give speeches, issue press statements, and testify before Congress…”

The first time the yuan controversy graced your Whiskey’s pages was back in April 2005 . At that time, the bipartisan brotherhood against China, honorable Sens. Schumer and Graham, were spouting the virtues of a hefty 27.5% tariff on Chinese exports.

What do you know? These guys never expected it to pass. They just hoped it would be a loud trumpet call. Bush personally appealed for them to withdraw the bill, with a sort of wink. Try again next year. And try they have.

Smoot-Hawley Redux: China 01.01.2008

For a quick history review, let’s jump back to 1930. Sen. Reed Smoot and Rep. Willis Chatman Hawley birthed what became the highest tariff in U.S. history.

Historically, Republicans love a high tariff. And Smoot, from Utah, a beet sugar growing and wool producing state, was no exception. Over 1,000 economists petitioned President Hoover to say nay. (Just like today, when 1,028 economists signed an anti-protectionist petition over the China currency war.)

Yet Smoot-Hawley went off without a hitch. The maximum 53% tariff hit 900 manufactured items and 70 agricultural products. The result was so dastardly that even today’s State Department history page chalks it up as a failed enterprise.

Smoot-Hawley outraged foreign nations. Historian Richard Hofstadter labeled Smoot-Hawley "a virtual declaration of economic war on the rest of the world." It’s easy to see why.

In just two years time, 25 countries fought back by raising their duties, decimating U.S. foreign trade. America had exported $5.24 billion in goods in 1929. By 1932, the total was just $1.6 billion. Total global trade declined 66%.

Believe it or not, in the depths of the Depression, Smoot only argued that the tariffs were probably not high enough. In 1932, Hawley didn’t manage to get re-elected. Nor did Smoot, who was edged out by a Democrat. Yes, this was the high-water mark of U.S. protectionism.

So perhaps Congress is suffering from a bad case of amnesia… Thus, today’s Smoot-Hawley: the Fair Currency Act of 2007.

Handing Down Judgment From the Land of Deficit

In deconstructing the Senate bills that comprise this so-called Fair Currency Act, I was troubled by three things:

a) What right do we have to determine the true value of someone else’s currency?
b) With what mechanism can we enforce that right?
c) With what knowledge do we act to ensure the “right” outcome?

Here are the salient developments from Senate Committee bill S.1607:

It’s up to the secretary of the Treasury to identify these rouge currencies that are in “fundamental misalignment.” The identification checklist includes:

  • A current account surplus (viz., trade surplus) compared with U.S. deficit
  • Same outrageous surplus scenario with other trading partners
  • Level of foreign direct investment
  • Huge foreign currency reserves.

And there’s this gem of a clause: “Pursuing any other policy or action that, in the view of the secretary, warrants designation for priority action.”

Now of course, the objective methodology for computing this misalignment has actually yet to be established.

But the “punishment” will be adding a tariff on top of the export price — adjusting it to the “natural” price. But in order to get that process off the ground, the U.S. would have to get the IMF’s director on its side.

The director would have to establish that Article IV of the IMF Articles of Agreement was indeed violated. This means proving China is manipulating exchange rates to gain unfair advantage. Of course, that same Article IV also insists that members foster “a monetary system that does not tend to produce erratic disruptions” …this might impact the level of our own bargaining chips a bit, eh?

But going back to that checklist:

  • Yes, China’s $233 billion trade surplus with the U.S. in 2006 was the biggest ever recorded with a single country (at least until this year)
  • China’s surplus is rising against Europe and Japan, but it does have deficits with some countries, making the global surplus $177.5 billion last year
  • China has focused its foreign direct investment on energy/raw materials…meaning it imports at internal production prices, rather than that of global demand
  • China is sitting on $1.33 trillion greenbacks in currency reserves.

So OK, we have a currency manipulator, but what can we really do about it?

Forgive me for stopping, but let’s make this a double-barreled shot.

The reality of this yuan controversy is almost too laughable to press on without a pause for good reflection.

Catch you tomorrow, dear reader,
Samantha Buker

August 23, 2007

The Daily Reckoning