Hypocrisy?

[Crippler]

DUMB AND DUMBER
By Justice Litle

Last week, improved trade numbers gave hope that the
protectionist crowd might back off a bit. No such luck.
Since last week's figures, Washington has turned up the heat even further. On Friday, "safeguards" were imposed on Chinese textile imports (trousers, shirts, underwear).

On Tuesday, the Treasury Department, as part of a biannual report to Congress, threatened to accuse China of manipulating its currency if the yuan is not allowed to rise. The Financial Times notes that Beijing has been "put on notice," and the Treasury Department expects a revaluation "within six months."

At Outstanding Investments, my newsletter, we feel the Bush administration is risking the health of the global economy with these idiotic demands, and there could be implications for commodity prices.

In a recent column, Bloomberg columnist Andy ukherjee
notes:

"No safeguard can protect the $9-an-hour apparel-industry wages in the United States when 15 million people in China are cutting and sewing for an average 88 cents an hour. Indian textile wages are even lower. Free trade in textiles is valuable for the world's poor people because it came after three decades of oppressive quotas. Sacrificing it, to fix China or perpetuate a false sense of job security in
North Carolina, is too high a price to pay."

Blocking textile imports from China will not help the U.S.
textile industry. It will simply allow other low-cost
producers, like India, a chance to step in and fill the
gap.

Washington is willing to risk an escalating trade war in an effort to protect an industry that represents less than 1% of U.S. jobs, with tactics that don't even make sense in the first place.

This is all political calculus. Despite what the president
might say in public, free trade is not a priority of the
Bush administration. By pandering to the textile states,
the White House can buy political support for its other
struggling initiatives (like Social Security) and take
momentum away from the Democrats at the same time. The real-world consequences of these actions are simply brushed under the carpet.

The loud calls for China to revalue the yuan are equally
moronic. Whether you think it imperative for China to
adjust its currency quickly or not, browbeating, lecturing
and thinly veiled threats are not the way to go about
making a proud country do anything... especially not an
authoritarian country with global leadership aspirations
and a wide nationalist streak.

Imagine how the United States would have responded if the European Union had criticized Bush's tax cuts, demanding that they be repealed for the health of the global financial system. Or imagine if the United Nations had objected to the $295 billion highway bill making its way through the U.S. Senate at the moment on the grounds of fiscal profligacy. Dick Cheney would still be muttering expletives.

Yet in demanding a change in monetary policy, this is
exactly what the United States is doing to China.
Regardless of the economics behind an immediate China
revaluation, Washington gets a big fat "F" for
effectiveness (let alone diplomacy).

The hypocrisy of the situation makes it even worse: China is being singled out because it is clearly visible in the public eye, while the smaller Asian tigers are not. When you combine the mercantilist foreign exchange policies of South Korea, Taiwan, Singapore and Malaysia, the net effect of their manipulation is hugely greater than China's. But picking on the little countries doesn't make for good press, while standing up to the dragon does.

Geo-politically speaking, this is a no-win situation. If
China's leaders are forced to revalue sooner via the
strong-arm tactics and threats of Washington, they will
privately feel bitter, angry and humiliated. And what is
the point of antagonizing an opponent to little gain? If it
is a friend, you have only hurt the friendship. If it is an
enemy, you only increase its willingness to do something rash in response to your threats.

There is also the very real chance that Beijing is more
afraid of the destabilizing effects of a premature
revaluation than it is of Washington's words. Given the
awful state of Chinese banks and capital markets, it
remains to be seen whether China can open the foreign
exchange floodgates without triggering a daisy chain of
crisis events. If Beijing maintains the peg out of fear, or
for some other hidden reason, then the war of words can only escalate, to no one's benefit.

Meanwhile, China remains the second largest holder of U.S. Treasurys, after Japan. By buying U.S. Treasury bonds, Chain has been indirectly financing the U.S. consumer, and the U.S. economy as a whole, as long-term interest rates have moved lower. The Senate appears completely oblivious to this. Bretton Woods II, our nickname for this long-standing trading arrangement with Asia, has allowed the United States to maintain its pace of spending in the first place. Now congress want to throw a spanner in the works.

What does all this have to do with the markets? Simple: An outbreak of protectionism is the single greatest threat to the health of the global economy, which in turn drives the demand for natural resources. Washington is risking everything for the sake of petty political gamesmanship. It is either too shortsighted to see what it is risking, or too cocky and overconfident to care.

Protectionism is a bit like a nasty virus. The global
economy is more susceptible to the virus when it is
weakened, as it is now, and it only takes one carrier to
spread the virus and cause an epidemic. We haven't seen a true outbreak yet, but I can tell you I'm worried about these developments.

On the bright side, the markets have brushed off the
Treasury's report, perhaps relieved that the language was more restrained than it could have been, or hopeful that a stalemate will persist.

[Hamish]

NYTimes
May 20, 2005
The Chinese Connection

By PAUL KRUGMAN
Stories about the new Treasury report condemning China's currency policy probably had most readers going, "Huh?" Frankly, this is an issue that confuses professional economists, too. But let me try to explain what's going on.

Over the last few years China, for its own reasons, has acted as an enabler both of U.S. fiscal irresponsibility and of a return to Nasdaq-style speculative mania, this time in the housing market. Now the U.S. government is finally admitting that there's a problem - but it's asserting that the problem is China's, not ours.

And there's no sign that anyone in the administration has faced up to an unpleasant reality: the U.S. economy has become dependent on low-interest loans from China and other foreign governments, and it's likely to have major problems when those loans are no longer forthcoming.

Here's how the U.S.-China economic relationship currently works:

Money is pouring into China, both because of its rapidly rising trade surplus and because of investments by Western and Japanese companies. Normally, this inflow of funds would be self-correcting: both China's trade surplus and the foreign investment pouring in would push up the value of the yuan, China's currency, making China's exports less competitive and shrinking its trade surplus.

But the Chinese government, unwilling to let that happen, has kept the yuan down by shipping the incoming funds right back out again, buying huge quantities of dollar assets - about $200 billion worth in 2004, and possibly as much as $300 billion worth this year. This is economically perverse: China, a poor country where capital is still scarce by Western standards, is lending vast sums at low interest rates to the United States.

Yet the U.S. has become dependent on this perverse behavior. Dollar purchases by China and other foreign governments have temporarily insulated the U.S. economy from the effects of huge budget deficits. This money flowing in from abroad has kept U.S. interest rates low despite the enormous government borrowing required to cover the budget deficit.

Low interest rates, in turn, have been crucial to America's housing boom. And soaring house prices don't just create construction jobs; they also support consumer spending because many homeowners have converted rising house values into cash by refinancing their mortgages.

So why is the U.S. government complaining? The Treasury report says nothing at all about how China's currency policy affects the United States - all it offers on the domestic side is the usual sycophantic praise for administration policy. Instead, it focuses on the disadvantages of Chinese policy for the Chinese themselves. Since when is that a major U.S. concern?

In reality, of course, the administration doesn't care about the Chinese economy. It's complaining about the yuan because of political pressure from U.S. manufacturers, which are angry about those Chinese trade surpluses. So it's all politics. And that's the problem: when policy decisions are made on purely political grounds, nobody thinks through their real-world consequences.

Here's what I think will happen if and when China changes its currency policy, and those cheap loans are no longer available. U.S. interest rates will rise; the housing bubble will probably burst; construction employment and consumer spending will both fall; falling home prices may lead to a wave of bankruptcies. And we'll suddenly wonder why anyone thought financing the budget deficit was easy.

In other words, we've developed an addiction to Chinese dollar purchases, and will suffer painful withdrawal symptoms when they come to an end.

I'm not saying we should try to maintain the status quo. Addictions must be broken, and the sooner the better. After all, one of these days China will stop buying dollars of its own accord. And the housing bubble will eventually burst whatever we do. Besides, in the long run, ending our dependence on foreign dollar purchases will give us a healthier economy. In particular, a rise in the yuan and other Asian currencies will eventually make U.S. manufacturing, which has lost three million jobs since 2000, more competitive.

But the negative effects of a change in Chinese currency policy will probably be immediate, while the positive effects may take years to materialize. And as far as I can tell, nobody in a position of power is thinking about how we'll deal with the consequences if China actually gives in to U.S. demands, and lets the yuan rise.

E-mail: [e-mail]

[con's fly is open]

It's about time. The yuan trades at, say half of what it's really worth. China is getting away with murder, stealing jobs. It's not hurting Canada so much, since we lost most of our manufacturing jobs to America in the NAFTA deal, but Yankee jobs have been decimated.

I don't blame the Chinese for cheating, but the U.S. for letting them. Anything less than a floating currency meanes a free ride for one party. I'll concede that doing it instantly would devstate China, but America is well within their rights, nay, it is in their vital interest, to demand a timetable for valuing the Renminbi.

[George61]

On the other hand, maybe the "dollar" should float down to its true value!!

[Newbs]

I'm no economist. I've just been to the shop outside the school gate and bought things worth 21 yuan. I handed over a hundred yuan note and I got 79 yuan in change, and I'm still trying to figure out if the shopkeeper cheated me, I cheated the shopkeeper, or we're both square.

However, this yuan valuation thing is interesting. I think any kind of 'retaliation' by the US congress will be couterproductive. Hell, you have to have been in China all of 5 minutes before you can see that the Chinese won't take kindly to someone else telling them what to do. The Chinese have a point, BUT they are the ones who have decided to peg their yuan at 8.28 to the US dollar. These guys also trade with the EU, Australia and (dare I mention it) Japan.

You're right Con when you say that instantly floating the yuan would be devastating, but perhaps pegging it to a basket of currencies might be a start.

[Mr Nobody]

Nah, I think they are doing it right. Short floats, see how it goes. Peg it for a while. Float, etc.

The whole world would go down the tubes if they floated it completely.

But then, I am a git with not much idea of international economics. I think the Yuan is worth maybe half as much again, and I hope they float it in about six months after I get there, heh. I have bills to pay.

On the other hand, the antipodean peso will get flogged.

[No Moss]

Well, the yuan will revalue some day. It is patently unfair for an economy the size of China to undervalue its currency, but it might start biting China's behind, too. The problem the Chinese are having is that so much money is flowing into China, both as trade surplus and investment, that the economy is overheating. Here's what that means: too many factories are being built, too many businesses are being started, too many office buildings are being constructed. When production of goods and services exceeds demand, the economy wilts--that's called a recession. (Technically, two quarters of negative growth.) If you "cool down" the economy, or reduce its rate of growth, you don't have that problem. The cheap yuan and low interest rates mean that China gets a lot of foreign investment, and that keeps the economy hot.

China will lose value in their American financial investments when they revalue the currency, but this problem will just get worse the longer they delay the inevitable revaluation.

Personally, I believe that China will significantly revalue the yuan within 6 months. The loud pressure is coming from America, but there is also pressure from Europe and other trading partners.

[Mr Nobody]

Hey, how about that? My blind shot in the dark may be close. Unfortunately, my investments are all currently in the aforementioned antipodean peso. Plus, looks like the income from the business is still going to roll in without me.