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Beijing, Washington and Currency Manipulation

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Apparently not satisfied with two wars, a national debt approaching $14 trillion, and endless partisan bickering, Congress now wants to pick a fight with China. On March 15, 2010, the collective "wisdom" of our elected representatives was resplendently displayed in a letter essentially demanding the Obama administration consider a revival of the Smoot-Hawley Tariff Act. Only in this case Washington would not be targeting all foreign imports, just those from China. Not to worry, China is only our second largest trading partner...this won't have much effect at home...in the short run. Or at least before the November elections, the 130 legislators listed as signatories hope.

This congressional effort to relive the events of 1930 assumed additional speed on March 16, when five senators including Charles Schumer (D-NY) and Lindsey Graham (R-SC) introduced legislation echoing the infamous letter. The proposed bill -- hereafter the Schumer-Graham Tariff Act -- would compel the Treasury Department to declare China a currency manipulator. The Schumer-Graham Tariff Act would also facilitate the imposition of import duties as a means of compensating for any perceived currency manipulation. In other words...back to Smoot-Hawley.

Why all this shouting from the rafters? Congress -- with its extensive economics experience and obvious comprehension of all financial issues -- believes China is a "currency manipulator." More specifically, the Capitol Hill denizens believe that "by pegging the renminbi to the U.S. dollar at a fixed exchange rate, China unfairly subsidizes its exports and disadvantages foreign imports."

Do the Chinese do this? You bet. Why? The Chinese Communist Party wants to maintain an economic growth rate that exceeds 8% a year as a means of generating employment and thereby providing their population of 1.3 billion a lifestyle most Americans would reject as outright deprivation. Furthermore, some analysts estimate an immediate revaluation of the yuan would result in the loss of 5 million Chinese jobs. In either case, members of the Chinese government, like politicians in Washington, realize employment and take-home pay matter. If Beijing fails to look out for her constituents, well, a number of Chinese politicians will be looking for work.

So here's what Beijing has done. Since July 2008 -- the point at which it became apparent our banking crisis was going to cause a global recession -- China locked the yuan to the dollar at an exchange rate of 6.83 to 1. This move came as a bit of a shock, as apparently many Western analysts figured China would be sucked down the economic sinkhole with everyone else. The technocrats in Beijing were not so inclined. After allowing the yuan to appreciate 21% against the dollar between July 2005 and July 2008, they decided to protect their peoples' jobs -- and thus remain atop China's political hierarchy.

Washington was not as logical. In a desperate bid to save their buddies on Wall Street, our elected representatives began exploring a means of printing more money and handing out bundles of cash. This worked for Wall Street -- one look at the bonuses offered at Goldman Sachs last year confirms greed is good -- it did nothing for Main Street. In a concerted effort to save their own hides and maximize profits, the banks who willingly accepted taxpayer cash refused to lend this taxpayer largess back to small businesses or anyone not employed at J.P. Morgan. The ultimate result, unemployment slithered past 10%.

To make matters worse, our representatives on Capitol Hill could not agree on how to spend a stimulus package...thereby causing jobless rates to lock in...just about as tightly as the yuan peg to the dollar. The Chinese government--by the way -- not only managed to spend its stimulus package in a timely manner, Beijing also worked to place responsibility for maintaining growth outside the central bank by encouraging lending in the private sector. (Yes, yes...I realize no minor element of this private sector borrowing was accomplished by local governments tasked with infrastructure development. The point is, Beijing didn't simply go out and print more yuan -- aka the U.S. Treasury solution -- China's government sought to employ domestic savings.)

Back to Washington. What does the wise U.S. politician do in such a situation? Blame someone else...no, blame everyone else. The problem, of course, is that pointing fingers at our own ruinous financial system will not work. After the Supreme Court ruling in Citizens United no self-preserving politician is going to go after Wall Street. Nope, far easier to look outside the border and highlight the biggest, scariest target one can find. That used to be the Soviet Union...now it's China.

Now here's the rub. The Chinese are no longer willing to abide this silliness. The opening salvo from Beijing came on March 14, 2010, when Chinese Premier Wen Jiabao told reporters, "We oppose mutual accusations between countries, and even using coercion to force a country to raise its exchange rate, because that's of no help to reforming the yuan exchange rate. We don't believe the yuan is undervalued."

I have to give Wen credit -- he didn't stop with this bit of defensive rhetoric. No, Wen chose to pitch the grenade back in Washington's court. American politicians like to claim the Chinese are pursuing mercantilist policies, Wen declared we are protectionists. More specifically, he argued, "I can understand some countries' desire to raise exports, but what I do not understand is depreciating one's own currency and attempting to pressure others to appreciate, for the purpose of increasing exports. In my view, that is protectionism."

That's right, Wen declared Washington is engaged in currency manipulation so as to encourage exports and thereby preserve American jobs. Stated more bluntly, Wen was highlighting Washington's hypocrisy. On March 16, Beijing turned up the heat. A spokesman at the Chinese commerce ministry told reporters, "We hope that U.S. companies in China will express their demands and points of view in the U.S., in order to promote the development of global trade and jointly oppose trade protectionism." Seems the Chinese have been watching President Obama's public squabble with Justice Roberts over Citizens United...only Beijing appears to understand Citizens United can be used to buttress their cause.

And Beijing's thoughts on the Schumer-Graham Tariff Act? An unnamed official at the Chinese commerce ministry simply noted, "We oppose the over-emphasis on the yuan's exchange rate." According to this official, the yuan would remain pegged to the dollar. As he put it, "We have repeated ourselves multiple times. And we cannot be any clearer."

Alas, the Chinese are up against a wall on this issue. Even the august Paul Krugman is advocating the reinstatement of Smoot-Hawley. (My bet, Krugman does not share Ben Bernanke's interest in studying the Great Depression.) In his March 15, 2010 New York Times column, Krugman suggest we place a 25% tariff on Chinese goods if Beijing does not back down on the yuan. Damn, even Smoot-Hawley was not that draconian...Krugman must have a secure gig...he sure seems unconcerned about potentially plunging the U.S. back into a severe recession.)

So what is Beijing to do? First, ignore the noise from Capitol Hill. If we have learned anything in the last 18 months, it is that our elected representatives are incapable of coming to agreement on anything important. The proposed Schumer-Graham Tariff Act will inevitably run into opposition and grandstanding -- or get buried in health care reform and overhaul of our financial regulations. Second, put pressure on U.S. corporations with operations in China. These corporate entities are sure to loose a pack of lobbyists and cash in an effort to preserve their profits by preventing a repeat of Smoot-Hawley. Third, engage the White House. President Obama has enough problems at home -- he does not need to rile our largest foreign creditor.

I'm not kidding on that final point. On March 16 -- in the midst of all this sound and fury -- Tim Geithner told reporters the Schumer-Graham Tariff Act is "just an illustration of how strongly people feel about this." Geithner also avoided direct questions concerning plans to name China a currency manipulator. Instead the Treasury secretary pledged to "work very hard to make sure that U.S. firms will be able to compete on a level playing-field with China, in China and in the United States." (Hint: go back and see my advice about pressuring U.S. firms with interests in China.)

And what about Washington? What can Washington do to end this row. First, become conversant in the facts about China's economic development. The yuan is slowly appreciating at home, Chinese labor prices are rising, and Chinese consumers are now starting to spend. (Beijing now rules the world's largest automobile market.)

Second, call off the dogs. The rhetoric is only going to abet Chinese intransigence on this issue. Having suffered through the century of humiliation, increasingly nationalistic Chinese citizens are not about to take orders from any foreign government -- and will certainly not accept such an act from their civil servants. Finally, Washington can pursue this issue through tangible efforts to address our own financial disaster. The Chinese are likely to be much more willing to take risky moves with the yuan when Washington no longer appears on the brink of declaring bankruptcy.

My parting thought, this is no time for a new Smoot-Hawley or a squabble with the Chinese. We need to get Congress back to work on substantive issues and save the off-shore finger pointing for more appropriate targets. I leave it to you to name the guilty parties.