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.

Posted by Jim Newton on Oct 11 2011. You can follow any responses to this entry through the RSS Feed. Comments can be made below.