The war, alas, is not over. Mercantilism is back. Its adherents use new lingo and make slightly different arguments—they hoard jobs, not gold—but their poisonous creed is in essence the same. It is that a nation can enrich itself by boosting exports and chasing imports away. Mercantilism is behind the campaign to make the Chinese revalue their currency upward. The preposterous notion here is that America would be enriched if Chinese apparel cost a little more.
Three developments have converged to put Adam Smith‐style free trade on the defensive. First, central banks—led by the Federal Reserve—have begun to mop up a huge liquidity overhang. Consequently, global growth has decelerated, and according to the global composite leading indicator series published by the Organization for Economic Development it will continue to moderate. Second, the U.S. trade deficit will hover at record levels for at least the next two years. Third, China has increased its “contribution” to the U.S. trade deficit from 9.4% of the total in 1990 to 24.4% last year.
Washington’s modern‐day mercantilists believe trade deficits can be managed by altering exchange rates. Therefore it’s not surprising that China’s currency, the yuan, is in the crosshairs. According to the Washington consensus the yuan is undervalued. This allegedly makes our imports from China artificially cheap and our exports to China artificially expensive. To level the playing field, the managed traders recommend an upward revaluation of the yuan. This solution has broad support. The Bush Administration wants it, the China Currency Coalition wants it, and Senators Charles Schumer (D-N.Y.) and Lindsey Graham (R-S.C.) want it. They have a bill, up for vote in July, to slap an across‐the‐board 27.5% tariff on Chinese imports if China fails to revalue the yuan within six months.
Is the yuan really too cheap? Since June 1995 the yuan/dollar rate has been set in stone at 8.28. Now adjust the nominal exchange rate for inflation rates in China and the U.S. If inflation in China has been less than in the U.S., then the real value of the yuan would have fallen relative to the dollar and China would have become more competitive. That is, there would be some logic to the Schumer‐Graham attack on the exchange rate.
As it turns out, during the last decade the real value of the yuan has depreciated by only 2.4%. It’s not surprising that the Cleveland Fed concluded that: “Overall, movements in China’s real exchange rate since 1995 have not given that country a trade advantage relative to the U.S. or, for that matter, to China’s other key trading partners.” It’s clear that China stands accused on false charges. It’s not the first time, nor will it be the last.
This brings us to another question. Would the legislation proposed by Senators Schumer and Graham be legal? It would clearly break the World Trade Organization’s rules. Among other things, the U.S. would trample on China’s Most Favored Nation status under the WTO treaty.
But members of Congress don’t seem to give a hoot about breaking WTO rules. Just take the antidumping amendment of Senator Robert Byrd (D-W Va.). Senator Byrd slipped it into an agricultural appropriations bill in 2000, and supposed free‐trader Bill Clinton signed it into law. The Byrd statute allows U.S. companies to file antidumping petitions, have tariffs imposed and then divide up the loot. The WTO recently ruled the Byrd amendment illegal and authorized other countries to hit the U.S. with retaliatory tariffs unless Congress repeals it.
Not surprisingly, the yuan revaluation proposals remain silent on how they would make China better off. During the last decade China has avoided the Asian financial crisis of 1997–98, grown at over 9% per year and suffered less inflation than the U.S. Why? Because it had a fixed yuan/dollar exchange rate of 8.28. A revaluation of 27.5% would throw all that overboard and generate at least a 20% deflation in China, among other things.
I smell a nasty trade war and a consequent weakening of trade‐led economic growth. All those risk‐oblivious speculators borrowing at low rates to invest in high‐yielding junk and emerging market bonds will be deep trouble. You should go the other way. Sell junk and emerging market debt. Buy Treasuries.