May 18, 2005
Currency cold war
Less than a week after it re-imposed quotas on Chinese-made cotton trousers, cotton knit shirts and underwear, the Bush administration now says it will set new quotas on a number of items that China can ship to the U.S.—men’s and boys cotton and man-made fiber shirts, man-made fiber trousers, man-made fiber knit shirts and blouses and combed cotton yarn. And inevitably the administration resorted to darker threats:
The administration on Tuesday stepped up pressure on China to overhaul its currency system, which manufacturers and other critics also blame for the soaring U.S. trade deficit and the loss of American factory jobs. The Treasury Department threatened to brand China, if it failed to change its currency policy soon, as a manipulator of currency. That designation could lead to economic penalties against Beijing.
Over the past two years, the administration has tried to prod China to stop linking its currency, the yuan, to the U.S. dollar. American manufacturers say China’s system has undervalued the yuan by as much as 40 percent. The weaker yuan makes Chinese goods cheaper in the United States and American products more expensive in China.
Odd, I thought cheaper goods were one of the key benefits of globalization and free trade. And I’ve yet to see a convincing argument that restricting cheap imports of anything has saved a single industry: preventing consumers and businesses from buying cheap doesn’t mean they’ll buy pricey. But as The Economist points out, that’s not the only snag:
China’s currency peg, at around 8.28 to the dollar, is widely believed to be keeping the yuan undervalued by 15-40%, making Chinese exports artificially cheap. But it also subsidises a great deal of America’s profligate spending. In order to maintain the peg, China is forced to buy loads of dollars, which are then dumped into US Treasury bonds, financing America’s hefty deficits. A sudden decline in Chinese demand for Treasuries would raise America’s borrowing costs, curbing Congress’s ability to dole out pork to constituents. Some economists fear that this would push interest rates up sharply enough to cause a sharp contraction in the debt markets (including the mortgages that are fuelling America’s housing boom) and the economy.
Moreover, the magnitude of any revaluation—10% is optimistic—is unlikely to make much of a dent in the trade deficit:
China accounts for less than one-tenth of America’s trade, so even a 10% revaluation would only reduce the trade-weighted value of the dollar by 1%—not enough to produce any noticeable change in America’s current account. Nor is it clear that even a big revaluation would help much. Morris Goldstein of the Institute for International Economics estimates that even a 25% revaluation would reduce the current-account deficit by less than 5%.
Still, some kind of revaluation appears likely—even though the latest economic statistics suggest that China’s overheated economy may be starting to cool off. Until then, expect Bush to keep fighting his currency cold war.
Posted by Stephen at 10:26 PM in Economics | Permalink | TrackBack (0)
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