Cost of unleashing China's currency

Congress: Be careful what you wish for.

By William H. Overholt and Pieter Bottelier

from the July 13, 2007 edition

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Santa Monica, Calif.; and Washington - Congress has become obsessed with the Chinese currency. Forty-two members recently demanded formal action against China under Section 301 of the 1988 Trade Act. The Bush administration rejected that, so a powerful group of lawmakers is proposing a bill that would make China vulnerable to antidumping penalties for alleged currency misalignment. Major presidential candidates have advocated heavy tariffs on imports from China if it fails to appreciate its currency.

Why is this happening? US job losses in manufacturing industries and the trade deficit with China – which amounted to about $230 billion last year according to US government calculations – have put many American elected officials under pressure to do something.

Congressional critics say China's undervalued currency is the root of the problem. While China's currency may well be undervalued, the fundamental causes of the job losses and the trade deficit actually lie elsewhere. Sometimes solutions that seem like common sense and draw popular support turn out to be ineffective when examined more closely.

It's true that low-wage Chinese workers have taken jobs from Americans and that cheap Chinese imports have pumped up the trade deficit. But three other factors explain the state of US-Chinese trade:

•The low savings rate by Americans means the US will continue to have a large global trade deficit. Forcing Chinese currency appreciation will just shift the deficit to other countries.

•When Congress focuses on the currency issue, it is addressing the least important source of the US trade deficit.

•If Congress pressures the Inter-national Monetary Fund to censure China regarding its currency, the IMF might be obligated to censure the US for its domestic economic policies that are a more important cause of its global trade deficit.

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