Currency Issue Still a Red Herring

Following are some thoughts from a broader analysis of mine on  the state of U.S.-China relations, which will be published in the near future.

Between July 2005 and July 2008, the Chinese RMB appreciated by 21 percent against the dollar.  But over that 3-year period, the U.S. trade deficit with China increased from $202 to $268 billion.  Why, then, do policymakers think revaluation is the key to reducing the trade deficit?  Why do they even care about the bilateral trade deficit, which is meaningless in the context of our globalized economy.  Only one-third to one-half of U.S. imports from China is Chinese value added.  The rest is Japanese, Taiwanese, Korean, Australian, American and other countries’ value added.  The bilateral figures tell us nothing important.

During the aforementioned period of RMB appreciation, U.S. exports to China increased by $28 billion.  But U.S. imports from China increased by $94 billion.  Americans continued to purchase Chinese imports–despite the currency-induced price increase–for two primary reasons.  First, there aren’t many substitutes for the Chinese products U.S. consumers tend to purchase.  Second, Chinese exporters, by virtue of a stronger RMB, were able to reduce their costs of production because many of those costs are for imported inputs (made cheaper because of the stronger RMB), which subsequently enabled them to lower their prices for export to the United States.

There is no compelling reason to think things will be different this time.  Thus, all of the hollering, name-calling, and finger-pointing can only worsen the state of bilateral relations.

There are less provocative alternatives.

If it is desirable that China recycle some of its estimated $2.4 trillion in accumulated foreign reserves, U.S. policy (and the policy of other governments) should be more welcoming of Chinese investment in the private sector. Indeed, some of China’s past efforts to take equity positions or purchase U.S. companies or buy assets or land to build new production facilities have been viewed skeptically by U.S. policymakers, and scuttled, ostensibly over ill-defined security concerns.

As of the close of 2008, Chinese direct investment in the United States stood at just $1.2 billion—a mere rounding error at about 0.05 percent of the $2.3 trillion in total foreign direct investment in the United States. That figure does not come anywhere near the amount of U.S. direct investment held by foreigners in most of the world’s medium-sized economies, nevermind the large ones. U.S. direct investment in 2008 held in the United Kingdom was $454 billion; it was $260 billion in Japan; $259 billion in the Netherlands; $221 billion in Canada; $211 billion in Germany; $64 in Australia; $16 billion in South Korea; and even $1.7 billion in Russia.

In light of China’s large reserves, its need and desire to diversify, America’s need for investment in the real economy, and the objective of creating jobs and achieving sustained economic growth, U.S. policy should be clarified so that the benchmarks and hurdles facing Chinese investors are better understood. Lowering those hurdles would encourage greater Chinese investment in the U.S. economy and a deepening of our mutual economic interests.