No time for scapegoating or retaliation
Last week in a procedural vote to move along a piece of legislation, the U.S. Senate voted by an overwhelming margin of 79 to 19 to establish a mechanism to retaliate against countries that consistently and intentionally undervalue their currencies. While the legislation may seem evenhanded in its treatment of every currency manipulator, it is squarely directed against the Chinese government which is, to the surprise of nobody, keeping the yuan undervalued so as to encourage both production and employment in their domestic export sector. Needless to say, if the yuan is undervalued, then the U.S. dollar is overvalued, and if the Chinese artificially expand their export activity, then the U.S. will see its export sector unfairly restrained.
While this effort does not yet represent a final piece of Senate legislation (with the House not yet acting upon it), the proposed bill has widespread support from both sides of the aisle. Seemingly, the whole matter is quite intuitive and straightforward, but perhaps the obvious is not quite so much so when examined objectively. On such a basis, one might wonder if the Senate’s action is more political than economic.
For example, over the past couple of years, many governments around the world — including the Chinese — have complained that the U.S. is a major currency manipulator. Back in August 2010 when Federal Reserve Chairman Ben Bernanke announced the imminent implementation of the second round of quantitative easing (QE2) — where the Fed purchased $600 billion of U.S. Treasury securities — virtually every major trading partner claimed it was a deliberate attempt by the Fed to drive down the value of the dollar and expand the U.S. export sector at the expense of our trading partners; exactly the same position the U.S. is now taking with regard to the yuan. So incensed were some of our trading partners that they indicated they would intervene in world currency markets to prevent the dollar’s value from falling too much, as we saw earlier this year with Japan’s intervention actions. Even now, some suggest the Fed’s latest effort, Operation Twist, is another blatant attempt to lower U.S. longer-term interest rates and the accompanying value of the dollar.
Charges of U.S. hypocrisy aside, one next has to wonder what might happen should the Chinese be labeled currency manipulators by America and punitive import restrictions ensue. Would the Chinese government, unable to respond in any meaningful way, simply buckle under U.S. pressure? While it might be quite satisfying to suppose the answer is yes, it seems unlikely.
Generally when countries unilaterally engage in trade restrictions, economic retaliation tends to occur. So, as the U.S. imposes import restrictions (via tariffs and/or quotas), it is not unlikely that the Chinese government would respond in kind. In both countries, employment and production levels associated with the impacted industries would fall and potentially cause turmoil at a time of near-economic stagnation here in the U.S. As well, should the Chinese wish to further punish the U.S. (and in the process punish themselves through the mechanisms of international trade), they could refrain from further purchases of U.S. Treasury securities, or even sell a portion of their already significant holdings. Should this happen, U.S. interest rates could spike and further weaken the anemic economic expansion, quite possibly driving our nation’s economy into a renewed recession. After all, it seems as though our economy is already teetering on the brink of recession, so any significant deterrent to growth such as a trade war or protectionist legislation could prove as self-destructive as the Smoot-Hawley Act of the Great Depression era.
So, does this analysis suggest the U.S. simply suck it up and be a chump to the Chinese government’s self-promoting currency manipulation? Obviously, no, this is not a viable option, any more than setting off a nasty trade war will further America’s interests.
The answer? The same one that has always been available to us for many years, that is, filing a formal complaint with the World Trade Organization (WTO) rather than acting unilaterally. And since many other countries have complained similarly about Chinese currency manipulation (including Japan and the European Union), a formal complaint by the U.S. would undoubtedly be joined by others and make Chinese retaliation less likely.
Of course, such a course of action may not feel as good as going into the matter with economic guns ablaze, but the outcome could be less self-destructive and more long-lasting for all countries involved.
Dr. James Newton serves as chief economic advisor to Commerce National Bank and is an auxiliary faculty member in economics and statistics at OSU-Marion and OSU-Newark. Dr. Newton’s views do not necessarily reflect those of Commerce National Bank or OSU-Marion/Newark.