On Wednesday, October 12, the US Congress passed three trade agreements after five years of hold ups in the Bush and Obama administrations. This is a victory for US manufacturers, employers and consumers, the economy’s short-run and long-run projections, and the world as a whole. It is also a rare example of our legislators’ ability to come together in a time of need to improve our future. Yet in the same week, the Senate passed a bill to punish China for its currency manipulation. As Jimmy Meixiong points out, despite its intentions to the contrary, the bill presents potentially detrimental consequences for world trade.
Export Promotion as Key to Economic Recovery
Hopefully, last week marks the beginning of a larger policy movement toward boosting exports to hasten and strengthen our recovery. The US runs a trade deficit of about $45 billion. This was not always, however, a bad thing. Although American producers are not selling as many goods as they would like, consumers are getting goods in greater quantities and at lower prices that they would without the trade. In addition, basic balance of payments says that with a deficit in the current account (of which trade is a part) comes a surplus in the capital account. That is because countries use the extra dollars they have from US purchases of their products to invest in US businesses, infrastructure, and the national debt through the purchase of Treasury bonds. When investment demand outstripped national savings in the pre-crisis consumption boom, this foreign capital was necessary.
Today, however, the US should be aiming to balance its trade deficit. American consumers are not looking for more goods to buy; instead, they are saving at elevated rates due to economic insecurity and risk aversion – traits associated with our continued deleveraging process. This means more money is available for domestic business investment – there is a greater supply of loanable funds for banks to lend out to businesses – and less capital is needed from abroad. Boosting domestic business investment is integral to both our economic recovery and our long-term economic viability. Excess capital from abroad, on the other hand, serves to depress interest rates, which may aid expansionary monetary policy actions in the short run but threaten to undermine the Fed’s ability to control inflation when our recovery strengthens. This happened in the run up to financial crisis as exporters, especially emerging Asian economies, parked their money in safe Treasury bonds and kept interest rates low despite the Fed’s efforts to raise them. This could fuel another bubble in our next recovery. And crucially, exports increase employment in the production and provision of goods and services, a dire necessity considering our stubborn unemployment rate.
While the trade deals may have only a minimal impact due to the small size of the targeted markets, they are undoubtedly a step in the right direction.
Punishing China: A Risky Proposition
The merits of Congress’s other recent move on trade are not nearly as clear. The bill that passed the Senate would allow Treasury to impose harsh trade barriers on any nation found to be manipulating its currency to the detriment of US companies, specifically China. While the bill is unlikely to make it to the floor of the House given opposition in the Republicans’ upper ranks – and the President’s lack of vocal support for it – its passage in the Senate alone has sparked Chinese retaliation. Indeed, the benefits associated with the unlikely scenario that China will rapidly appreciate its currency are outweighed by the costs of the more likely outcome – the start of a trade war.
That is not to say that Chinese currency manipulation is a minor issue. One estimateputs the number of jobs lost over the past decade due to China’s aggressive devaluation of its currency, the Yuan or Remnimbi, at 2.8 million. By effectively subsidizing exports and taxing imports, the Chinese government has hindered US economic recovery and that of other world competitors. And meanwhile, the Chinese consumer must pay more for imports and the Chinese producer pays more for inputs and wages. This is a classic demonstration of the mutually detrimental effects of restricted trade.
The bill passed in the Senate, however, is not the solution. The bill presents two possible outcomes, both of which have huge potential costs to world economic stability. One is that China does not sufficiently appreciate its currency and the US institutes massive trade restrictions. This would prevent China from importing key goods, and China would surely respond with more trade protections. This would derail global trade, hurting both parties and the world as a whole.
The other option is that China does let its currency rapidly appreciate. This is dangerous in the short-run given the Chinese economy’s heavy dependence on exports, which would get hammered were China’s currency to rapidly gain value. China is the second largest economy in the world, and this shock would surely reverberate throughout the globe, hindering global recovery. In addition, appreciating its currency would require China to buy substantially fewer Treasury bonds – or dump already-held bonds onto the market – both of which would lower bond prices and raise US interest rates, counteracting the expansionary efforts of the Fed. This could severely hamper an already weak economic recovery at home.
Paul Krugman, in emphatic support of the bill, ignores both of these potential outcomes, arguing that the severity of our unemployment crisis makes any move toward fixing it – even one as risky as threatening a trade war with China – worth the costs. While the current rate of Chinese currency appreciation is certainly too slow, creating policies that will cause it to appreciate at exactly the right speed to avoid a Chinese downturn – assuming that speed could even be identified – is no easy task. Add in how little we know about the inner workings and motives of the Chinese Communist Party, and you get a daunting task with very little chance of success.
Yet all hope is not lost. China’s currency depreciation has led to rising inflation levels over the past several years, slowly making Chinese goods less competitive and bringing some manufacturers back to US soil. Meanwhile, the US has the option of suing China in the World Trade Organization, as there is a strong case to be made that Chinese currency manipulation is in violation of WTO rules. We should also be expanding funding for the Export-Import Bank, protecting copyrights and intellectual property abroad, and removing trade barriers that once made sense for national security.
Instead of risking a trade war with China, Congress should vigorously promote free trade and shy away from policies that threaten to hinder it. Despite the complex trade-offs of the globalized economy – including the particularly complex China situation – protectionism is still not the answer.
PHOTO CREDIT: Politico
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