If Mitt Romney is elected, it will be interesting to see how he extricates himself from his oft‐repeated public pledge to label China a currency manipulator on his first day in office. Actually, maybe not. Reneging on campaign pledges hardly warrants any contrition from today’s breed of politicians. They don’t do shame.
And there’s precedence.
A few months after assuming office in 2009, President Obama — after trumping Senator Clinton in the primaries with earnest commitments to re‐open and renegotiate the North American Free Trade Agreement on terms allegedly more favorable to U.S. interests — met with Canadian Prime Minister Stephen Harper and Mexican President Felipe Calderón to say, “uh, just kidding.”
There are several important reasons why a President Romney will renege on his pledge.
First, unless the semi‐annual Treasury Department report to the Congress on foreign currency practices — due out this month but “courageously” delayed by President Obama until after the election — isn’t issued in the lame duck period, there will be no actionable basis upon which to label the Chinese currency misaligned. The next report that would enable a President Romney to label the Chinese currency misaligned — an action that statutorily would prompt “consultations” (as if that were a novelty) between the U.S. and Chinese governments — won’t be published until April 2013 at the earliest.
Second, as President Obama (once a Chinese currency antagonist himself) learned quickly, currency policy is a very complicated issue with implications and consequences bleeding into all realms of economic policy. Do U.S. presidents really want to orchestrate price increases, real income declines, and cost of living increases for middle‐class and lower‐middle class American families? Are U.S. politicians — fiscal wizards they’ve demonstrated themselves to be — qualified to dictate policies to foreign governments with their own economic problems that could adversely affect one‐fifth or more of the world’s population? Is it moral for American debtors to tell their Chinese creditors to write down the value of their investments in U.S. debt, particularly while out‐of‐control borrowing and spending by the U.S. government continues unabated? Is America prepared for the commodity and other demand‐driven price shocks that would be triggered by a rapid appreciation in the buying power of 20 percent of the world’s population? I rather doubt these questions will be answered in tonight’s debate, but contemplating them helps explain the vast differences between the political rhetoric and policy reality surrounding the Chinese currency issue.
Third, there is no (none, zero, zilch) evidence in the public domain that an appreciating Chinese yuan will lead to economic growth and job creation in the United States. The supposition (the “assumptive close” as its called in sales) has been that a rising yuan would lead to a reduction in the bilateral deficit and that reduction would lead to job creation in the United States. But there is no discernible inverse relationship between the value of the Chinese currency and the size of the bilateral deficit or between the size of the bilateral deficit and the number of jobs in the U.S. economy. In fact, this analysis and this post and the links within it demonstrate that a rising yuan is more closely associated with a larger bilateral U.S. trade deficit, which is associated with more jobs — not fewer — in the United States.
If the Chinese currency is undervalued, its effect on U.S. business and job creation is negligible. China is a prominent export‐processing economy, which means that its factories import lots of raw materials and intermediate goods to stoke the machines and processes that manufacture and assemble the finished goods it exports to the United States and elsewhere. If the currency is undervalued, those imported inputs have been costing more to Chinese producer/assemblers than they should. And some of those higher costs have been passed onto consumers in the form of higher prices. If the currency were forced to appreciate, the costs of those inputs would decline, reducing the cost of production and the cost of final goods to U.S. consumers. Those agitating for currency legislation have only considered the impact of currency values on final prices and not on the cost of production. Accordingly, they have been wrong, as this post and the links within it will attest.
Fourth, economists used to be in widespread agreement that the Chinese currency was undervalued — although there was vast disagreement over magnitude. While there are still likely many more economists who believe the currency is undervalued than not, the prices of imports from China have been rising fairly consistently since 2007 (with a brief hiccup during the recession of 08–09), as this chart from the St. Louis Federal Reserve Bank demonstrates. And there is growing evidence that opinions about the value of China’s currency are or will be shifting.
In recent months, there have been many reports like the one on the front page of today’s Wall Street Journal about investment outflows from China. Wealthy Chinese have been trying to get their assets out of China, probably as a hedge against the uncertain future of the Chinese economy under its new leadership — and for the simple fact that economic growth rates will be halved this year from last and maybe halved again next year. If China lifted its restrictions on the capital account, it’s evident that there would be much more capital flight than there has been, given the circuitous routes that must be taken to get resources out of China under its restrictive system. If that flight by Chinese nationals spooked foreign investors enough to deter capital inflows, there could be significant downward pressure on the Chinese yuan under a free‐floating currency regime, in which case the currency is now overvalued, not undervalued.
Fifth, currency is the last decade’s battleground. If Mitt Romney believes in “free trade,” his focus with respect to China should be on correcting that government’s failures to honor all of its commitments to liberalize and on the misguided efforts by U.S. policymakers to thwart legitimate commerce between Chinese exporters and American consumers.