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Friday, April 2, 2010

Ya Lookin’ For A Trade War, Partner?

We had the cold war, and then Reagan’s War on Drugs, and his joint venture war in the Falklands with his girlfriend, Margaret Thatcher, which brought us the War against Saddam, by Pappy Bush, for drinking the oil milkshake located in Kuwait; next, we moved on to LittleBoyBush’s War on Terror, which brought us to the Iraqi Freedom War, and the War in Afghanistan. President Obama continues the presidential legacy of finding something to call “War”.

Now, President Obama has found his own voice of war by calling out the Chinese for keeping their Reminbi (RMB) undervalued as a currency, and pegged to the dollar. We are now hearing calls by those in Congress for a Trade War. Oh, how we love the sound of war, and its sweet destructive affects upon the lives of millions of people here at home and elsewhere.

Recently, we have heard from five of our dear Congresspersons looking for a fight with China. Senator Charles Schumer, of New York, and Senator Lindsey Graham, of South Carolina, and three others showed their fangs after taking their cues from Mr. Obama. It looks like there is a cram of 130 Congressional pack hounds standing behind the five snarling government dogs that have introduced legislation that would label China as a currency manipulator and are pressing the Chinese currency to float more freely. They are pressuring Tim Geithner to call out a statement that China is a currency manipulator. The Treasury department will decide if China should be labeled as such. It hasn’t been since 1994 that such a designation had been authorized.

China’s prime minister did not waste anytime unleashing his own growls upon the five Viagra induced Congressional pitbulls. Bloomberg reported, by Randow and Salamat (“Roubini Sees Trade War…”), that Mr. Fan Gang, a Chinese central bank advisor, said “China “may resume a managed float of its exchange rate” if the global economy stabilizes and uncertainty around the economic outlook diminishes.” What is he thinking? That the only way that China will rebalance their currency is when the global economy stabilizes? 

Nouriel Roubini, economics professor at NYU, said, “As long as the U.S. won’t take immediate action against China there will be negotiations. But the Chinese clearly stated that if the U.S. were to brand China a manipulator and took action right away, the Chinese wouldn’t stay idle, they would take retaliation.” Now, that sounds like war! The U.S. likes a good war, and the groundwork is being laid out for it to possible happen.

Chinese commerce minister, Chen Deming, warned that there could be trouble in River City if the U.S. levies a punitive tariff on Chinese imports into their most favored trading partner. U.S. consumers will be suffering more than anyone. He went on to say, “If the United States uses the exchange rate to start a new trade war, China will be hurt. But the American people and U.S. companies will be hurt even more.”

Chen knows how life is in the U.S., since he spent time at Harvard University. He doesn’t understand why the Obama administration believes that threats will accomplish his goals. “You’re not going to get 1.3 billion Chinese to change by insulting them….economically it makes no sense.” He doesn’t believe that the U.S. trade deficit will decrease by limiting imports. What will the U.S. do? Will it put tariffs on all foreign imports? Is it only targeted at China? Will China get around it by producing consumer goods in Taiwan, Vietnam, Mexico, or South Korea? The only way to effect the trade deficit would be for Americans to save more of their incomes and reduce their overall consumer spending practices; or to push the dollar lower and increase U.S. exports.

Mr. Chen made reference that the U.S. will probably not be producing their own telephones or televisions anytime soon in order to cover the loss of those same products being imported from China. “That production isn’t going to return to America, that’s just not practical. Globalization has changed all that.”

It is my belief that Mr. Chen is mistaken. The U.S. could start producing such products again if the Obama administration stimulated, i.e. subsidized, the manufacturing sectors as the Chinese have done over the past years.

China’s Premier Wen denied that the RMB was undervalued when he said, “I understand that some countries want to increase their share of exports. What I don’t understand is the practice of depreciating one’s own currency and attempting to press other countries to appreciate their own currencies solely for the purpose of increasing one’s own exports. This kind of practice I think is a kind of trade protectionism.” (Found on, 3-17-10). Professor Michael Pettis (Michael Pettis is a professor at Peking University’s Guanghua School of Management, where he specializes in Chinese financial markets, and a Senior Associate at the Carnegie Endowment for International Peace) wrote, “Wen is absolutely right! Undervaluing or depreciating a currency certainly is a form of trade protectionism, but that, I think, is exactly the point. In a world of sluggish growth and rising unemployment, everyone’s currency policies are legitimately going to be scrutinized over whether they constitute trade protection.”

Here is more of the arrogance oozing out of the Chinese government, (as written in “How Will an RMB Revaluation Affect China, US and the World”), by Professor Michael Pettis) and spoken by Zhao Qingming, a researcher with China Construction Bank as he stressed that imbalance’s of an economy’s deposit and investment were the fundamental reasons for a nation’s trade surpluses or deficits. “Exchange rates have only minor influence. In fact, yuan appreciation brings more adverse effects to western countries than positive ones. In the past tens of years, because of the yuan devaluation and export rebate policies, western countries, to a large extent, were able to enjoy low inflation, low living cost, and current standard of living, and western governments were able to reduce financial deficits and allow their people to consume excessively.”

This is Professor Pettis’ response. He wrote that the first part of Zhao’s statement is basically correct, but he is way off with the second part of his distorted view of a devalued currency. “The second part is certainly wrong and probably meaningless. More interestingly, it seems a little weird to argue that one of the benefits that China has provided the world with its undervalued exchange rate is low consumer prices that allow countries like the US “to consume excessively”. Aside from the fact that this pretty explicitly acknowledges that the currency is undervalued, since excess consumption is exactly the problem in the US, and since Chinese per capita consumption is much less than 10% of that of the US, it seems that China should be more approving of US attempts to return the favor and allow Chinese consumers the benefit of subsidizing US prices.”

Mr. Michael Whitney, (“The Looming Trade War With China”), brings up the following impressive viewpoint. He quotes Mr. Chen, (extracted from Washington Post, China’s commerce minister: U.S. has the most to lose in a trade war”) “If the United States does decide to impose tariffs on China, American companies operating in China, which account for more than 60 percent of China’s exports to the United States, would surely be hurt the most. ‘In the end, America is the one that needs to adjust’”. Chen continued, “One reason why a revaluation would be dangerous for China, is that profit margins for Chinese exporters are tiny—ranging from 1.7 to two percentage points.”

Mr. Whitney asked, “does anyone seriously believe that the corporations would slit their own throat by starting a trade war? Consider this: Maybe China’s “currency manipulation” policy was just one of the many preconditions demanded by foreign corporations before they relocated to China. Naturally they would want to ensure that they’d have an advantage over the competition regardless of the costs to China or workers in America. In other words, the multinationals are probably the driving force behind the exchange rate.”

Ms. Carolyn Bartholomew wrote in The American Prospect (“The Great Industrial Wall of China”), “China policy has, over the past two decades, been driven by the interests of the multinational corporations, and those global firms have benefited from many of China’s policies. Starting several decades ago, it was a handful of exporting elite—Boeing, Motorola, and GE among them—who argued persuasively to the Bush, Clinton, and Bush administrations that the U.S. economic interests would be served if only these companies had access to the Chinese consumers…As more and more companies signed on, and the investment banks got involved, production shifted to China…”.

“Instead of adjusting our trade and economic policy, U.S. policy-makers adjusted the rationale for the continuation of a status quo that was failing the American worker. Of the estimated 1.94 million U.S. jobs lost to China since China’s economic reforms started 30 years ago. 1.05 million of them—over half—were lost since China acceded to the WTO in 2001….Today, of course, we see the result of that sort of thinking. With the global economic crisis, American workers have ended up without jobs and without pension funds.” “At the behest of the U.S. based multinationals, Washington has championed the causes of corporate interests masquerading as free trade.”

This viewpoint is the crux of what globalization has done to the American worker. It sounds like we are being distracted, and redirected from the real cause of our trade deficit by our Congress and President Obama. Mr. Whitney pointed it out to us, which is that U.S. corporations walked away from the American worker in order to find the cheapest labor force with a stable government; and that was China. Outsourcing was the result, yet we were conned into believing that outsourcing would be good for us. We would have more leisure time as we invested our savings with the “financial experts”, and in return, we would have more dividend and capital gain income. WOW! Wasn’t that a crock of nothin’stuff!

What appears to be a solution to the trade deficit might not be to force China into revaluing their currency, but to tell American corporations that if they continue to produce outside the country and import goods that were once made in America back to us we should tariff those products and tax those corporations. That could be the framework for a rebalancing effort.

Professor Pettis wrote, “Although Premier Wen noted again in his speech…that China is “worried” about the value of its US dollar reserves, perhaps as a warning that China would counteract any US trade move by selling off USG bonds, [Paul] Krugman doesn’t seem especially worried about this threat.” “[Krugman] said that if China were to sell all of its US investments, it would help the economy by acting as a form of quantative easing and fighting a “liquidity trap” that has recently been affecting the US economy.” “China was the top foreign investor [of] US government debt, with holdings of $898.4 billion in Treasury securities.”

Professor Pettis added that the main long-term impact of dumping USG bonds might be no more than to cause a liquidation of Chinese assets at very low prices, and an equivalent transfer of wealth from China to the US (or to others likely at some point to buy cheap dollar assets).

“An RMB rebalancing would impact with a decline in exports and shrinkage in their manufacturing. Foreign currency investors and those investing and stockpiling of commodities and other goods would also be negatively affected. The winners would be households. There would be an increase in personal wealth, growth in future assets and incomes, as well as an increase in consumer spending on imports boosting GDP.”

Professor Pettis begins to summarize, “Remember that each domestic imbalance requires the other, so that if China adjusts, the US must adjust, too, and if the US adjusts, China must adjust, too….Either way, the rebalancing in China will force an equivalent rebalancing in the US. As the price of Chinese goods rise, the net impact will be to transfer resources from US consumers, who have to pay more for their imports, to US producers (US producers become more globally competitive.) This rise in Chinese consumption relative to Chinese production would be necessarily matched by a rise in US production relative to US consumption.” (Investment is a factor in economic growth, as well.)

“Remember that trade surplus exists because of the imbalance between Chinese domestic production and Chinese domestic consumption (technically the surplus is the difference between savings and investment), and so anything that affects the subsidies to manufacturers, or that affects household income, will also affect the trade surplus.”

“Rebalancing just means that in China economic growth will be less than consumption growth, and in the US consumption growth will be less than economic growth….If the RMB revalues, this is the same as if all the currencies of the rest of the world depreciate….This is why policy coordination and gradualism is so important…China will rebalance, but it cannot do so quickly….Chinese producers have become so addicted to a wide variety of implicit subsidies, besides the currency, that they cannot possibly adjust very quickly. It will take years [8-10] of continuous adjustment to wean them away from an undervalued currency, too-low interest rates, excessive credit aimed at SOEs (State Owned Enterprises), and sluggish wage growth.”

So, do we have the time? Do the other trade deficit nations have time? Do other countries that want to revalue their own currencies have the time? Do 130 members of Congress and this administration have the time? Or, is a trade war on the horizon?

Thanks for reading, jerry
For Professor Pettis’ piece click here.