By Evan Abrams
Bashing China
for currency manipulation has become a popular refrain among American politicians.
Republicans and Democrats alike,
find it politically expedient to point the finger at China for the decline in
American manufacturing and stagnant wage and job growth in the middle class.
Their arguments tend to focus on export-led employment because that issue is
most salient to the voting public. However, the most pernicious long-term
problem caused by an undervalued Yuan is the yawning payments imbalance that
has emerged between the two nations.
China’s current
account surplus creates a capital account deficit, leading to an outflow of
foreign portfolio investments. This can help lead to asset bubbles and has been
blamed, by Ben
Bernanke and others, as contributing to the subprime mortgage crisis of
2007-2008. It also creates a strong market for United States treasury bills,
helping America to continue to live beyond its means. Conversely, the U.S.
current account deficit means that much of the growth in the American economy
over the past decade and a half has been financed by debt, both public and
private. This arrangement of debt financed American consumption of Chinese
goods is clearly unsustainable.
Of course, the
artificially low Chinese currency is not the only factor leading to the present
imbalance. Persistent U.S. budget
deficits have led to a national debt of roughly 18 trillion USD. The question is: who
will adjust to whom? In other words, will the current situation unwind
principally due to a decline in U.S. spending or an increase in Chinese
consumption? For U.S. policy makers, the latter is clearly preferable and an
adjustment in the value of the Chinese currency is a critical ingredient in
making that a reality.
Yet, while there
is ample evidence
that China’s currency is undervalued, there are few if any effective mechanisms
through which American policy makers could force an adjustment. The two most
obvious choices, in a multilateral context, would be the IMF and WTO. Article
IV, Section 1(iii) of the IMF
Agreement gives the IMF jurisdiction to review currency manipulation as it
relates to preventing a balance of payments adjustment or creating an unfair
competitive advantage. However, the power of the IMF to force a country to
change their policy is quite limited. This is particularly true of a country
like China who has no need for financial assistance from the IMF (China holds
nearly 4 trillion USD in foreign
reserves).
The WTO has a
well functioning dispute resolution system that can authorize retaliatory trade
sanctions in order to induce compliance. Thus, at first glance, the WTO seems
like it could be an ideal body to litigate this dispute. However, the WTO lacks
jurisdiction over currency issues, which have traditionally been ceded to the
IMF. It may be possible to argue that China’s undervalued currency amounts to
an illegal trade subsidy in violation of WTO rules. However, this would rub
against the traditional definition of trade subsidies and would be unlikely
to succeed before a WTO judge.
The domestic
options available to lawmakers are quite limited as well. Many politicians have
hammered home the necessity of labeling China as a currency manipulator.
However, such a designation is unlikely to produce any significant changes. The
1988
law that governs the labeling process empowers the Treasury Department to
initiate negotiations with the country in question, but does not authorize the
use of retaliatory trade sanctions. The U.S. has already been in prolonged
discussions with China regarding their exchange rate and it is unclear that
labeling China as a currency manipulator would do anything but ruffle feathers.
Finally, it is
important to understand that a sharp and sudden rise in the value of the Yuan
would be devastating to business and employment in China. This could have
serious ramifications on the Chinese economy, which would almost certainly
reverberate to the U.S. economy, and it could lead to widespread discontent
with the ruling communist party and a challenge to the Chinese regime. Chinese
leaders would not contemplate anything with the potential for such dramatic
domestic consequences and would fiercely resist U.S. efforts for a dramatic short-term
change in currency valuation.
A long-term,
gradual increase is more plausible but even this carries significant risks,
because any announced schedule for appreciation would likely place strong
demand on Yuan from speculators and investors, causing the currency to rise
more rapidly than intended or China to take strong corrective actions to hold
the rate steady.
So while the
current scenario is clearly unsustainable there is no obvious legal or
political mechanism to unwind the large imbalances that have developed. How
American and China navigate this thorny issue will help determine the economic
fortunes of their respective countries in the years and decades to come.
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