Leo W. Gerard: Your chapter in the new book, Benchmarking the Advantages Foreign Nationals Provide their Manufacturers, describes in devastating detail how China in particular, but also other major U.S. trading partners, violate international rules. The abuses you document make clear that it's impossible for American manufactures to compete internationally. U.S. corporations responded by off-shoring manufacturing and millions of American jobs. Why does the U.S. put up with this unfair trade?
Peter Navarro: The Bush administration put up with unfair trade because it was distracted by the war on terrorism and because of its blind ideological commitment to free trade, regardless of the unfair trading practices adopted by our trading partners. The Obama administration is putting up with unfair trade with China because it is under the mistaken notion that it's more important for China to keep financing our budget and trade deficits than for this country to crack down on unfair Chinese trade practices so that we can restore our manufacturing base. Consumers -- oblivious to the destruction that the Chinese have done to our job base -- have put up with this unfair trade because in the short run they get cheap Chinese goods. The National Association of Manufacturers puts up with this unfair trade because many of its members have offshored their production to China and now find it in their interests to oppose trade reform. What is critical in the politics of this whole situation is that the American people clearly understand how unfair trade practices translate into fewer jobs and lower wages and a bleak future. Only when the American people see the chessboard more clearly will our politicians act appropriately.
Gerard: The result of decades of losses is, as you put, the "hollowing out" of the U.S. economy. It depressed wages, lowered the standard of living, created recession conditions in the Midwest -- even before the current great recession. Typically, in the mainstream media, the loss of industry routinely is blamed on unions seeking what we believe is decent wages and benefits. Your chapter provides a shockingly different story. Why don't we hear that?
Navarro: Labor unions have become a common "whipping boy" for the recessionary ills that have afflicted the U.S. economy off and on for several decades now. One problem is that much of the financial press has a strong, antiunion bias. A second problem is the far too parochial nature of American politics. Far too many Americans -- and I include many members of the American press corps here as well -- simply don't understand some of the complexities of the global economic environment that have helped trigger the U.S. recession. The case of Chinese currency manipulation is a perfect example. Very few politicians or pundits -- much less the American people -- understand how China pegs the yuan to the dollar and how an undervalued yuan acts as a subsidy to Chinese exports to the United States and a tax on U.S. exports to China. Nor do these politicians and pundits understand how this currency manipulation affects the stock market or interest rates or the rate of off shoring. Because the effects of globalization are complex, labor unions make an easy target.
Gerard: For those unfamiliar, because it isn't covered much, would you explain how China can be both a mercantilist and a protectionist state, and the effect of that economic behavior on the U.S.?
Navarro: In thinking about the issue of trade reform, it is important to distinguish between mercantilism and protectionism. A mercantilist state uses tools like illegal export subsidies and currency manipulation to increase its level of exports to other nations at the expense of jobs and income in those nations. In contrast, a protectionist state uses unfair trade practices like quotas, forced technology transfer, and regulatory barriers to prevent foreign competitors from entering its markets. As a practical matter, any state that engages in protectionism likely also is a mercantilist as well. In the world arena today, China is the reigning Emperor of both mercantilist and protectionist practices. The scope of what this "beggar thy neighbor" country does in direct violation of the World Trade Organization rules is breathtaking, and it is precisely these mercantilist and protectionist practices that I outline in my chapter in the book.
Gerard: Can we talk for a minute about currency manipulation because this is something you hear a lot, but, again, it's rarely explained. You provide great descriptions in the chapter of why China's undervaluing the yuan "makes exports cheap and imports dear," as you put it. Can you give us a primer here?
Navarro: As a practical matter, any given country can choose between a fixed or a floating exchange rate system for its currency. In a floating exchange rate system, the value of the country's currency is determined by supply and demand conditions in the international market. Currencies that float and trade freely everyday include the dollar, the euro, the yen, and the Swiss franc.
In fact, floating exchange rates represent a crucial element of any free trade regime that benefits all nations. The reason is that floating exchange rates act as a natural market mechanism to prevent any trade imbalances between countries. If one country like the United States runs a trade deficit with another country like China, the value of its currency should fall relative to the other currency. A falling currency will boost that country's exports because its exports will be cheaper to sell while it will reduce its imports, because imports will become more expensive. In this way, the trade will come back into balance in a floating exchange rate system.
The problem is that some countries like China embrace the alternative of a fixed exchange rate system. In China's case, it tightly pegs the value of the yuan to the U.S. dollar. This means that no matter how big the U.S.-Chinese trade imbalance, the dollar can't fall relative to the yuan and bring trade back into balance.
China pegs the yuan to the dollar in a very complex process, but in a simplified example you can think of it this way. American consumers go into Wal-Mart and buy a bunch of cheap Chinese goods with American dollars, and these dollars are exported over to China. Ordinarily, the surplus dollars would put downward pressure on the value of the dollar relative to the yuan. However, to reduce these pressures the Chinese government sweeps up these dollars in a "sterilization" process which involves selling bonds to Chinese citizens at interest rates of a little more than 4 percent. China then turns around and uses these sterilized dollars to buy U.S. government bonds at interest rates of less than 2 percent -- thereby losing a considerable amount of money on the deal. The Chinese government is willing to incur these losses, however, because by buying US government bonds, it bids the value of the dollar back up so that China can maintain its dollar-yuan peg. At the same time, China's purchase of US government securities also helps lower US interest and mortgage rates -- a kind of financial heroin that makes America feel good even as China steals its jobs and destroys its manufacturing base using this currency manipulation as a weapon.
Gerard: I think that after the Olympics were held in China, a lot of people became aware of the high level of pollution there. So while American companies must pay decent wages and control pollution, Chinese companies don't. But you detail much more insidious internationally illegal competitive advantages China has over the U.S. One of those is forced technology transfer. Can you describe that?
Navarro: While currency manipulation and China's high levels of illegal export subsidies rank as two of its most important mercantilist practices, China's forced technology transfer represents one of its most insidious protectionist practices. The idea of forced technology transfer is that if a company like General Motors and General Electric or Intel wants to set up production facilities in China and sail into the Chinese market, it must surrender some of its technology to the Chinese in order to do this. This practice is, of course, one of the most blatant violations of the World Trade Organization. However, American corporate executives rarely challenge this practice because they are all too eager to play in the Chinese market. Over time, however, the practice of forced technology transfer in China is a one-way ticket to the destruction of the American technology base. If in the short run, American corporations surrender their technologies to China, eventually, over the longer run, China won't need these American corporations, and they will be quite ironically run out of China by their own evolved technologies.
Gerard: You describe virtually all of these practices as being illegal under international treaties or World Trade Organization rules. People who are so hot for free trade must know that China is violating these rules. Is it correct to say that the U.S. simply is not demanding enforcement of the regulations to its own detriment?
Navarro: That is absolutely correct -- the US government has failed abysmally at using the tools at its disposal to crack down on Chinese mercantilism and protectionism. The Bush administration failed to do so because of its preoccupation with the war on terror and its misguided ideology. The Obama administration is even more culpable because it fully understands the damage that China is doing to the American economy. However, the President, the Treasury Secretary, and the United States Secretary of State have all decided that it's more important that China continue to finance our budget and trade deficits than it is to challenge China on trade reform. The problem with this strategy is that it guarantees the long run secular decline of the American economy, which will come as an inevitable result of a further erosion of America's already weakened manufacturing base.
Peter Navarro is a best-selling author and CNBC contributor. His most recent book is "Always a Winner: Finding Your Competitive Advantage in and Up and Down Economy." Mr. Navarro is also the author of the worldwide bestseller, "The Coming China Wars," and the bestselling investment book, "If It Rains in Brazil, Buy Starbucks." He also wrote the management book, "The Well-Timed Strategy." With a Ph.D in economics from Harvard, Mr. Navarro is a business professor at the Merage School of Business at the University of California, Irvine. He is an expert in macroeconomic analysis of the business environment and financial markets. He has been featured on "60 Minutes," and his articles have appeared in publications such as "Business Week," "The New York Times," and "The Wall Street Journal."