Treasury Secretary Tim Geithner has announced that he will not make the April 15 deadline for determining whether our global trading partners—China in particular—are manipulating their currency “for purposes of…gaining unfair competitive advantage in international trade,” as required by the Omnibus Trade and Competitiveness Act of 1988.
The announcement drew swift rebuke from some administration critics including Iowa Sen. Charles Grassley (R-IA). “Everyone knows China is manipulating the value of its currency to gain an unfair advantage in international trade,” Grassley commented. “If we want the Chinese to take us seriously we need to be willing to say so in public.”
I share Grassley’s view that China is manipulating its currency. I also believe that the imbalance in trade and savings between the two countries is not just dangerous but could precipitate a global economic meltdown reminiscent of the Great Depression if major adjustments are not made expeditiously. But Geithner’s decision was the right one.
First, and most importantly, while the imbalance between the dollar and the Yuan has become a symbol of the overall imbalance between the two economies, it is not in fact a very big part of the overall problem.
Many believe that the Yuan may be undervalued by as much as 40 percent—it would probably be worth around 20 to 21 cents in U.S. dollars on the world currency markets in the absence of Chinese intervention instead of being worth about 14.5 cents in U.S. dollars. That sounds huge, and if Chinese products (go to Wal-Mart and take your pick) were 40 percent more expensive, there is little question that the bilateral trade imbalance would shrink dramatically, causing many things now made in China to once again be made here or in other countries more willing to buy American-made products.
Some might also argue that the resulting nearly 30 percent drop in the price of U.S.-made products for Chinese consumers might materially improve the prospects for U.S. exports to China, further boosting employment opportunities in the United States. But my view is that won’t happen. Chinese stores will continue to be stocked with Chinese products except when there is no domestic-made equivalent. If the volume of U.S. products shipped to China remains relatively constant and the unit price of those products declines because of the decline in the value of the dollar, no jobs will be created and the trade deficit as measured in Yuan or against a basket of world currencies will actually increase.
But how would a stronger Yuan affect the cost of Chinese manufactured goods shipped to the United States and would that create more U.S.-based manufacturing jobs?
The answer is probably yes, but the impact on our own labor market would be small if it is a concession involving nothing more than currency realignment. First of all, currency realignment would not only raise the value of Chinese exports, it would lower the cost of Chinese imports—a substantial portion of which are used to produce exports. If the Yuan were to rise in value to about 20 cents against the dollar, the price of a barrel of Saudi light crude measured in Yuan would drop from more than 530 Y to about 390 Y, or about 30 percent. Similar price reductions would occur with respect to iron ore, copper, and various types of equipment purchased from the United States and other Western countries to equip Chinese factories and increase the volume of Chinese exports. Savings on these imports would be passed along in the pricing of Chinese exports and a substantial portion of the increased price of those exports expected from currency realignment would disappear.
Secondly, the artificially low value of the Yuan is only one form of subsidy being provided to Chinese producers. These other subsidies take a myriad of forms including free land, subsidized or free utilities, no interest loans, artificially depressed wages (even by Chinese standards), and old-fashioned straightforward injections of cash by the government. China has demonstrated a willingness to use such subsidies even when the Yuan is undervalued and there is little credible evidence that such subsidies would not increase to the levels necessary to keep manufacturing facilities in operation and exports flowing if the Yuan were to appreciate.
Thirdly, an open and public confrontation with China is not the optimal manner in which to solve this problem. Critics of our China policy are correct in pointing out that we have not been nearly as tough as we needed to be over the years in informing the Chinese about the rules of the game and the consequences it they continue to blatantly and repeatedly violate them.
But Chinese leaders are in many respects just like leaders in other countries. They are politicians who keep a steady eye on how they are being perceived by their fellow citizens. One characteristic that they cannot afford to have attached to their public image is the inability to standup to Yankee domination. Teddy Roosevelt, understanding the severe limits to “gun boat diplomacy,” cautioned “walk softly and carry a big stick.” We need to be tough as hell in private and respectful of China’s sovereignty and independence in public if we want the largest possible concession from the Chinese.
Tougher action may ultimately be necessary and U.S. demands may eventually have to become public. But that is not how we should start. China has in some important respects moved in our direction in recent months and appears to be ready to make at least nominal concessions on currency—provided they are not publically pummeled before they have the opportunity.
We will pay a price if we eventually have no choice but to be confrontational in a way that will become public. A portion of our $70 billion annual export market to China will be placed at risk and for a time that may at least temporarily depress U.S. job growth. That is a price that we may need to pay, but it would be foolish, particularly at this point in our economic recovery, to take that route when private negotiations are likely to produce better results.
These negotiations must not be limited to currency since there are a host of other economic considerations that will better contribute to building a more balanced economic relationship. First and foremost we must insist that China act on behalf of its own people and take the steps necessary to allow Chinese households to consume the lion’s share of China’s productivity. As long as that nation’s economic expansion and job creation are largely dependent on export growth, its excessive and unmanageable horde of dollars will grow and burden the United States with long-term debts that it cannot repay through any credible scenario of expanded export earnings. But giving the Chinese households the capacity for greater consumption will require policy changes well beyond a stronger Yuan.
China currently has a savings rate estimated by most economists at close to 50 percent of gross domestic product. Part of that high savings rate comes from the Central Bank’s controls on the use of export earnings. But also important are other economic and social policies practiced by Chinese governments from the village level up to central party headquarters in Beijing.
A decent social safety net, something you might think would be a no brainer for a nation aspiring to be a “worker’s utopia,” has in recent decades become almost nonexistent. Nearly all hospitals belong to the state and nearly all doctors and nurses are employees of the state. But the funding provided to the health care system has been so inadequate that the only way ordinary families can get effective treatment is to pay doctors out of pocket. Since China has no private insurance system, families must maintain high levels of household savings to cover these medical expenses. Roughly the same is true of retirement costs because there is no comprehensive retirement system such as Social Security.
The lack of a publically financed safety net only partially explains why Chinese families are in a bind to build such high levels of savings. Another major factor is the exceeding low returns available to families on their savings. Inefficient or in some instances fraudulent banking practices are subsidized by the wide spread between the rates banks paid to Chinese families for their deposits (next to nothing) and the rates banks charge their customers. No matter how much a family saves, the low return available on savings forces households to build up massive accounts in order to obtain the minimal level of current income necessary to cover health, retirement, and emergency needs.
Another issue is wages. Chinese products are cheap because wages have remained artificially low. That is not simply a function of the size of the population and large pockets of underemployed workers. It is also a result of government policies that limit workers’ ability to organize or in other ways seek wages that are closer to those in other developing countries.
The Chinese government has made significant steps in recent months in dealing with these issues—steps that we should congratulate. But it is also too early to know what level of commitment the government has to these policies long term. They must therefore remain a top-level priority through the recovery phase of the current global recession and beyond. That is a bargaining issue that we cannot afford to lose on if we are to make real strides in correcting the dangerous economic imbalances between our two countries.
Reformers in China know the right path to take. They know that the longer China remains dependent on massive trade surpluses with the rest of the world, the more the nation is a risk of a cataclysmic readjustments—readjustments that could lead to great human suffering and quite possibly political turmoil. They know that the Chinese people should be able to consume much more of what they produce rather than loaning the profits made from their efforts back to much richer nations. They know that the service sector can produce far more jobs at a much lower cost per job than the misguided overdependence on manufacturing pursued by China over the past four decades. They know that chronic surplus nations such as Japan in the 1970s and 1980s or the United States in the 1920s often end up as the victims rather than the beneficiaries of their success.
What Geithner and others in the Obama administration must do is strengthen the hand of these reformers. China’s current economic wellbeing is ultimately totally dependent on one thing that we and we alone control—access to our market. They have no real recourse if we raise tariffs, impose quotas, or otherwise restrict that access. Of course they could slow the purchase of U.S. Treasuries and other dollar denominated assets, but that would only push the value of the Yuan higher and force a further deterioration in China’s capacity to export. They could impose countervailing tariffs but the outcome of such a trade war would be apparent from the outset with Chinese exports to the United States exceeding their imports from this country by a margin of more than 4 to 1.
The United States has since the early 1980s grossly mismanaged the considerable role it has played in promoting China’s emergence into the world economy. We have allowed the irrational exuberance of our nation’s commercial interests to dominate a relationship that is about a lot more than which American company can make the most by bringing cheap goods back from China or the preposterous notion once held by many companies that Chinese leaders will eventually hand them a meaningful share of the Chinese market if they behave themselves and bide their time.
The cost of that mismanagement has been severe for the United States. It has contributed to the decline in U.S. manufacturing, destroying businesses and jobs that might have thrived on a level playing field. Even worse, it has severely undercut investor confidence in the future prospects of U.S.-based production. And it has made it increasingly difficult for American workers to get any real share of the benefits from the hourly productivity gains that they have achieved over the past decade. It has created a world in which the capacity to produce greatly exceeds the capacity to consume, and growth in consumption necessary to avoid economic contraction has been leveraged through the destructive use of excessive credit.
China has also paid a big price. Unbridled industrial expansion has placed a huge and perhaps irretrievable toll on the Chinese environment, making some portions of the country virtually uninhabitable. It has spawned the unbridled expansion of inefficient enterprises, which governments at various levels continue to subsidize with Chinese households’ scarce and hard-earned incomes. It has strengthened and emboldened certain of the nation’s political elites who, contrary to earlier predictions, have not embraced democratic values as their experiment with capitalism produced mammoth personal fortunes. Too frequently these elites have thumbed their nose at the rule of law and at even minimal standards for human rights and civil liberties that are accepted by every other major economy on earth.
Our failure to address these issues over the decades has created the current morass and made the task now faced by Geithner and others in the Obama administration much more difficult. But the time to address that task is today, and the best way is through quiet diplomacy not a public spat over one of the many issues that must be resolved.
Scott Lilly is a Senior Fellow at the Center for American Progress.
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