Monday, April 18, 2005

China's Dollar Peg

There’s been some discussion on Drezner, Yglesias , Delong and Atrios about the Schumer bill threatening 27.5% tariffs on Chinese goods as a club to get the Chinese to revalue their currency.

That idea doesn’t look like a winner, for political reasons.

Tariff increases are a classic tit-for-tat situation. If the U.S. raises tariffs on Chinese goods 27.5%, then the Chinese raise tariffs on U.S. goods 27.5% --U.S. goods like airplanes and automotive parts. And before you can say Smoot Hawley, Boeing and GM are pounding on the White House door pleading for relief.

Especially since the Chinese pay close attention to the geopolitical and diplomatic facets of trade, and make a point of doing business with large multi-nationals that are willing to wield serious political clout on China’s behalf if a trade war erupts.

Also, I’m not expecting Wal-Mart to lumber into the Oval Office and announce to an anxiously sweating George Bush that it’s ready to suck it up and accept a couple years of higher costs and depressed earnings for the sake of a Hail Mary attempt to wipe out the American current account deficit with a punitive tariff.

I don’t see the classic Econ 101 solution—adjusting the exchange rate through a genuine float—happening either.

The Chinese have an exceedingly clear recollection of the great Asian financial crisis of 1997 that devastated Thailand and Indonesia among others. China escaped it, because it had not opened its fragile financial markets to fickle, easily-repatriated foreign capital. The lesson learned: if the RMB floats, it will be a managed float, with enough liquidity and transaction restrictions to ensure that the Chinese government will be able to control the rate in times of need.

Adjusting the exchange rate as a political concession to the U.S. is unlikely for a couple reasons.

First, the 8.3:1 peg has been very, very good for China. The weak RMB keeps China’s economy humming and millions employed busily if not happily. Picture those millions of ex-peasants unhappily roaming the streets of Chinese cities without family assistance or a social safety net if the Chinese export machine slowed down. The local Chinese governments are seriously and understandably spooked by the danger of mass urban unemployment that they are ill-equipped to deal with.

Second, China doesn’t feel like doing America many favors right now.

Within China, comparisons between the U.S. demands to Japan to allow the yen to appreciate in the late 80s—presented as a catastrophe for the Japanese economy cynically orchestrated by the United States -- and current U.S. pressure on China are encouraged. (The Chinese export-subsidy-through-artificially-low-exchange-rate strategy is strikingly similar to what the Japanese used to do, so the search for parallels is understandable.)

Today, from Kyrgyzstan to Japan to Taiwan, China detects a pattern of aggressive U.S. encirclement. A currency revaluation that would weaken China, boost perceived U.S. power in Asia, and render China more vulnerable to U.S. pressure and possible destabilization, is unlikely to fly with the Chinese leadership.

G7 carrots and IMF sticks are unlikely to change this stance in the short term.

And, with the U.S. economy headed for a slowdown, every fiber of the Chinese mercantilist being will be shouting for their government to keep the 8.3 to 1 peg and not price Chinese goods out of the market.

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