America’s Protectionist Drift

April 4, 2008 • Commentary
This article appeared in the South China Morning Post on April 4, 2008.

After several months of relative calm on Capitol Hill about US‐​China trade relations, leading House Democrats are making a noise.

They are calling on the Bush administration to employ “all available tools at its disposal to address China’s protracted, large‐​scale intervention in the foreign exchange markets to maintain an undervalued currency”.

In a five‐​page letter last week, Ways and Means Committee chairman Charles Rangel, and trade subcommittee chairman Sander Levin called for denying China a larger governance role at the International Monetary Fund unless Beijing stops intervening in the foreign exchange market. The letter was signed by 15 of the 24 Democratic members of the Ways and Means Committee.

House Democrats see the IMF as an ally in pressuring China to allow faster appreciation of the yuan. They are encouraged, no doubt, by the fund’s decision in June last year to monitor members’ exchange‐​rate policies with an eye towards achieving external stability and preventing fundamentally misaligned exchange rates.

Under this rubric, China’s persistent and large current account surplus, massive foreign exchange reserves and capital controls imply a “fundamentally misaligned” exchange rate, which would compel Beijing to consult the IMF. Mr Rangel wants concrete action to penalise China if it fails to comply with requests to realign its currency.

By a vote of 20 to 1 last summer, the Senate Finance Committee passed the currency exchange rate oversight reform act, hoping to counteract the “unfair trade” practice of maintaining a misaligned currency to gain a competitive advantage. Senator Lindsey Graham crowed: “No longer will the United States sit on the sidelines and allow other nations to gain an unfair advantage … For too long, the game has been rigged against American business.” Under the act, if China took no corrective action, the US Treasury could more easily label it a “currency manipulator” and take account of the undervalued yuan in determining duties under anti‐​dumping laws. Treasury officials would have to consult the IMF, but could recommend changes in governance to penalise China.

If Beijing continued to disregard the request for realigning the yuan, the US trade representative would be required to bring the case to the World Trade Organisation, for dispute settlement consultations.

Although this legislation has not passed Congress, it points to the path the US is likely to take in confronting China — especially the increased role of the IMF. Yet, the IMF has already lost much of its credibility, and countries with large foreign‐​exchange reserves can safely ignore its advice. It’s also unlikely the WTO would chastise a member for its exchange‐​rate policies.

The US cannot use the IMF to discipline members for failing to revalue their currencies in line with some unknowable “fundamental equilibrium exchange rate”. Moreover, America’s current‐​account deficit is not the result of China’s undervalued currency, although that may be a contributing factor. The major reason is that US domestic private investment exceeds domestic saving, and a bloated federal government is absorbing domestic saving for redistribution rather than productive investment. Unless the savings‐​investment gap is closed and the US budget deficit is reduced — by constraining the growth of government and reforming the tax code — American and global imbalances will persist.

Congress ought to be more concerned with excessive government spending and the massive imbalances in social security and Medicare than with the US‐​Sino bilateral trade deficit and the dollar‐​yuan exchange rate. The federal budget deficit is expected to grow to more than US$500 billion in the next fiscal year, and the present value of the unfunded liabilities in social security and Medicare now amount to nearly US$43 trillion.

House Democrats have conveniently ignored these problems and chosen to use China as a scapegoat in an election year. China faces increasing inflation and, thus, has an incentive to allow faster appreciation of the yuan, without being pressured by the US and IMF. China’s growth is an opportunity for American growth, as well, so Congress would accomplish more by correcting its protectionist drift than trying vainly to reduce China’s influence at the IMF and manipulate exchange rates to its liking.

If a new trade strategy is needed, it should be one that recognises the wisdom of philosopher David Hume’s statement in 1742: “Where an open communication is preserved among nations, it is impossible but that the domestic industry of every one must receive an increase from the improvements of the others.”

About the Author
James A. Dorn

Vice President for Monetary Studies, Senior Fellow, and Editor of Cato Journal