The economic illiteracy that drives the “revalue-your-currency-immediately-and-dramatically-or-else-we’ll-impose-a-27.5 percent tariff” mantra has become a huge political problem. The more that policymakers (and columnists) imply parity between the economic effects of a stronger Chinese Yuan and those of a huge import tax on Chinese goods at the U.S. border, the more likely we are to cross the precipice into astoundingly stupid economic policy.
On that score, Washington Post business columnist Steven Pearlstein deserves scorn. In his column on Sunday, Pearlstein touted his preference for populist bromides over any desire to comprehend and convey truth to his readers about trade. Pearlstein has joined the ranks of those agitating for an across-the-board tariff on Chinese imports since China “cannot take the one step that would restore some [trade] balance—revalu[ing] its currency.” Though Pearlstein has grown increasingly hostile to trade recently, Sunday’s column, in which he describes the upside of a massive levy against all Chinese imports, is probably the most irresponsible one I’ve read from him.
The “currency issue” is the most prominent source of contention afflicting the U.S.-China economic relationship. But it is merely a proxy for broader concern over the U.S. trade deficit with China. From the large and growing deficit, many policymakers conclude that we are losing at trade, and we’re losing because China is cheating. Intervention in the currency market by China’s central bank to keep the Yuan artificially low is the chief form of cheating, which acts as a subsidy on exports and a tax on imports. Fix the currency manipulation, and you fix the trade account.
That is an extremely simplistic take on the cause and effect of Chinese intervention in the currency market.
And even if trade balance or a trade surplus were a legitimate and worthwhile objective of policy, measures to encourage consumption in the surplus country or to encourage savings in the deficit country or some combination of both would be the proper course of action. (Note: To those who believe a trade surplus should be the objective of policy, take a look at Japan and Germany. Both have had large and persistent trade surpluses for decades. But for the better part of the past two decades, Japan has experienced anemic economic growth. Germany, during the same period, has had mostly double-digit unemployment. Meanwhile, the United States, with its large and growing deficit, has experienced steady, consistent economic growth and job creation over the same period.)
But the trade account has very little to do with trade policy. Attempts to achieve greater trade balance by tinkering with trade policy levers, particularly the levers that discourage trade and investment altogether, should be avoided. The trade account is a function of habits of savings and consumption, which are to some degree a function of fiscal and monetary policy, as well as relative confidence in local institutions and general outlook.
In that regard, last week’s Strategic Economic Dialogue between U.S. and Chinese officials in Washington was quite successful. Of course the meetings were characterized by those who fail to look beneath the surface as the last chance for China to bow to U.S. demands and avoid sanctions. That the Chinese didn’t say “how high” in response to U.S. demands to “jump” is evidence of the failure of the SED. But the SED is part of a process, and that process has yielded very important progress (if progress is defined as movement toward greater trade balance, which has become a political, rather than an economic, necessity).
In the weeks leading up to last week’s SED congregation in Washington, through its conclusion on Thursday, all sorts of incremental steps have been taken in the name of achieving greater trade balance. The Chinese announced a broader band within which the Yuan can fluctuate on a daily basis. The Yuan can now appreciate more quickly than in the past. Since July 2005, the Yuan has appreciated by over 8 percent against the dollar. It is now on a steeper appreciation trajectory. (But has it even occurred to anyone that the deficit has only grown larger during this period of Yuan appreciation? That fact certainly hasn’t deterred the currency-or-sanctions hawks.)
In response to a U.S. WTO complaint filed in March, the Chinese agreed to cut export tax rebates, which allegedly subsidize Chinese exporters, and to reduce certain import taxes, which allegedly hamper import competition in China. Also, the Chinese agreed to improved market access for U.S. commercial airliners and other industries, and they agreed to go on a shopping spree to boost U.S. exports (even though U.S. exports to China have been growing by leaps and bounds – by 32% in 2006 versus about 15% overall).
But in my view, the most important breakthrough last week was China’s decision to open its financial services sector even further than it has bound itself to do under its WTO commitments. This is more important than anything the Congress is raging about in Washington because it addresses a huge structural impediment to Chinese consumption: the dearth of consumer credit, life insurance, and disability insurance markets. The scarcity of these services encourages thrift, as medical emergencies, education expenses, big ticket purchases, and expenses related to catastrophic events must be financed, in most cases, from personal savings.
Treasury Secretary Henry Paulson has long held that the key to improving the trade balance is encouraging Chinese consumption. The Chinese government is trying to encourage that as well. Paulson’s suggestion that U.S. financial services providers can help in that task (given how skilled we are at consuming), and China’s acceptance of that proposal is testament to the validity and value of the SED.
While Schumer and Graham and Pearlstein advocate dropping the bomb, Paulson and Schwab and Wu Yi contemplate the keys to a successful bilateral relationship with economic growth for all.