Inconvenient Facts on Currency

Earlier this month, the Treasury Department released its semiannual “Report to the Congress on International Economic and Exchange Rate Policies.” The report’s key conclusion, that China is not a currency manipulator, was met with incredulity on the part of a number of members of Congress, some of whom suggested that Treasury’s “inaction” would move Congress closer to enacting provocative legislation to compel China to allow the yuan to rise.

The belief fueling this get-tough rhetoric is that the undervalued Chinese yuan is the primary cause of the $200 billion U.S. trade deficit with China, and that appreciation of the Chinese currency will restore greater balance of trade. But here’s a novel idea: before expending more energy grandstanding about the impact of the insidious yuan, devotees of the currency conspiracy theory might first attempt to validate their premises by looking at the relationships between other currencies and our respective bilateral trade balances.

What they would find is that other factors, such as changes in relative incomes and wealth, might play a more significant role than currency values in determining trade flows. For example, the U.S. dollar declined by 30 percent against the Canadian dollar between 2002 and 2005, yet the U.S. deficit with Canada increased by 58 percent. The dollar depreciated by 32 percent against the euro over the same period, and the deficit with the 12 euro-using EU countries increased by 33 percent. Likewise, the greenback decreased by 14 percent against the Japanese yen over the period, yet the deficit with Japan increased by 18 percent.

Of our 10 largest trade partners (which account for 75 percent of U.S. trade), eight have free-floating currencies (Malaysia’s and China’s are tightly managed). The currencies of seven of those eight appreciated against the dollar over the period of 2002 through 2005 (only the Mexican peso declined relative to the dollar). Despite pronounced dollar depreciation, the U.S. bilateral deficit increased with respect to 7 of those 8 countries (it decreased slightly with Taiwan).

What is so tiresome about the strident rhetoric from Congress is that it doesn’t stand up to simple analytics. The staffs of Senators Schumer and Graham must have access to some basic trade data and a pencil sharpener. Assuming they do, they might also notice that U.S. exports to China are soaring in 2006. First quarter figures from this year show a 39 percent surge in exports over the same period last year, which far exceeds the 14 percent growth in total U.S. exports and the 17 percent growth in U.S. imports from China.

Yes, the yuan has actually appreciated by about 4 percent since last summer, and greater currency flexibility is in China’s interest. But U.S. export growth is more a function of rising Chinese incomes than of relative price changes caused by currency movements. After all, U.S. exports to China grew at a rate five-times faster than exports to the rest of the world between 2002 and 2005, a period during which the yuan-to-dollar ratio was almost entirely constant.

In other words, U.S. exporters should and do welcome rising Chinese incomes. Punitive sanctions, such as the 27.5 percent tariff under consideration in the Schumer-Graham bill, would stunt Chinese income and choke-off access to our fastest-growing major export market. Congress should get out of the way and allow economics to run its course.

Ironic side note: Of the 33 countries to which U.S. exporters have sold over $1 billion worth of products so far this year, the two fastest growing markets from the same period last year are China (39%) and the United Arab Emirates (91%), both countries that have been so warmly embraced by Congress in recent months. That’s no way to treat the customers.