Wednesday, May 18, 2005

Impotent Treasury Department + Economic Policy as Political Football = Another Attack on China's Exchange Rate Policies

From the LA Times:

In unusually harsh language, the Treasury Department, in a report to Congress, described China's 10-year-old exchange rate regime as "highly distortionary" and said it posed a threat to the global economy. Unless Beijing moves to a more flexible exchange rate system quickly, the report said, China is "likely" to be cited for currency manipulation, which would open the door for sanctions.

After all that snarling comes the rather contradictory call for China to continue manipulating its currency a baby bit more--but to our benefit.

Snow said the U.S. wasn't calling for an "immediate full float" because "China's banking sector is not prepared. What we are calling for is an intermediate step that … allows for a smooth transition — when appropriate — to a full float."

Not surprising, politics and not economics are at the bottom of this.

We shouldn't ignore the fact that Karl Rove has apparently taken over direction of domestic policy and sees all events--including relations with China--through his uniquely Machiavellian, short-term political prism. Under Rove's influence, I expect that the deference to the pro-China qualms and moderation of "Poppy Bush" that President Bush displayed during his first term may be at an end.

Paul Blustein of the Washington Post captured the underlying political dynamic nicely on May 11:

... the momentum in Washington is clearly in favor of turning the screws on Beijing over the currency issue. The administration's change in tactics is especially striking.


Asked what has prompted the recent hardening in their position, senior administration officials observe that circumstances have changed. For one thing, China's overall trade in goods and services was in deficit in the first quarter of last year, but the nation finished up the year with a trade surplus of $32 billion, and in the first quarter of this year its surplus was about $16.6 billion.

Moreover -- though administration officials are loath to discuss it publicly -- Bush's chief trade initiative this year, the Central American Free Trade Agreement, is in trouble on Capitol Hill, and by proving its mettle on China the White House stands a better chance of attracting pro-CAFTA votes from reluctant Republican lawmakers.

The markets responded positively to the move, not because they think a genuine reform of China's foreign exchange regime is in the offing--which might bring about the collapse of the Chinese economy, end the PRC's ability to fund our deficit, crater the West's financial markets, and perhaps bring an end to civilization as we know it--but because they believe that the Chinese will be forced over the next few months to make a political response to White House pressure and tweak the exchange rate in a limited, non-disruptive way as a purely political concession, and that will lead to an increase in exports and profits for some companies, and thereby goose the stock market.

It doesn't look like using an RMB revaluation as part of a serious attempt to reduce America's yawning current and capital account imbalances with the rest of the world is anywhere near the table.

That means a serious discussion on China's exchange-rate regime--and a terrifying foray into the mind-melting realm of macro-economics--can be postponed once more. Phew!

Nevertheless, I think it's worth exploring Morris Goldstein's views. Mr. Goldstein is a well-respected economist at the Institute of International Economics.

Mr. Goldstein has been proselytizing for the last year or so for a staged, managed Chinese revaluation of the RMB, designed to correct an undervaluation he pegs at perhaps 15% to 20%.

Therefore, he has been dragooned, I suspect unwillingly, into the role of providing academic credibility for the White House's whack-a-mole approach of using an economic club to try to resolve what it sees as transient political nuisances--in this case, the political heat Mr. Bush is attracting from the large trade deficit with China.

Mr. Goldstein and other economists apparently agree that a Chinese revaluation by itself would have minimal impact on America's trade deficit.

If I understand Mr. Goldstein's views correctly, the only way that the political and diplomatic costs of confronting China on its exchange rate policies can be justified as an economic imperative is if a Chinese revaluation triggers a revaluation by the whole host of Asian exporters--Japan, Taiwan, Singapore, and Taiwan that takes a $70 to $80 billion bite out of America's trade deficit.

He believes China and the other Asian exporters should and would nobly shoulder this onerous, unprofitable, and unpleasant burden because they know the alternative is a catastrophic hard landing for the United States and the world economy.

But, since the United States apparently feels that there's nothing better to do than play politics with this issue and demonize the Chinese in order to score domestic political points, I think his hopes for display of a trans-Pacific display of spirit of consensus and sacrifice--or even an exhibition of enlightened self-interest by the U.S. government-- are perhaps misplaced.

The current U.S. policy reminds me of the joke where a cuckolded husband surprises his wife in bed with her lover. The husband pulls out a gun, points it at his own head, and snarls "Don't laugh. You're next!"


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