Brief Blog: October 1, 2010 – Yuanna trade war?

As I predicted in June, despite pressure from the Administration, China hasn’t allowed the yuan to rise quickly enough for American sensibilities. Unions and manufacturers continue to gripe that the yuan’s low valuation unfairly favors China’s exports, making it impossible for U.S. companies to compete and costing American jobs. House lawmakers, concerned about keeping their own jobs, are taking aim at China.

So on Wednesday, the House easily passed the “Currency Reform for Fair Trade Act,” which would allow U.S. companies to petition the Commerce Department for protective tariffs against imports from “countries with misaligned currencies.”

Turnabout is fair play.

With exquisite timing, while the House was preparing to vote in Washington, the World Trade Organization was conducting a review of U.S. trade policy in Geneva. The WTO warned the U.S. against “anti-recession measures,” including “provisions that favor domestic suppliers of goods and services.”

China’s ambassador to the WTO, Sun Zhenyu, told the review board, “[China] is very much concerned how the U.S. would take practical and responsible measures to prevent the dollar glut and maintain the stability of the currency.” Sun went on to observe that the dollar has depreciated for eight years while the U.S. government pursues an expansionary (print and spend) monetary policy. Sun noted in particular quantitative easing – - the Fed’s practice, since the financial crisis, of buying its own bonds (Treasuries) and other assets to expand its balance sheet. Touché.

In a global version of “how low can you go,” a dozen or so countries are simultaneously trying to devalue their currencies. Each nation wants to increase exports and decrease imports to encourage its citizens to buy domestically manufactured goods.

That construct may have worked a half century ago, but today it’s not that simple. In the 21^st century, we have what renowned economist Monty Guild describes as a global trade machine:  Components from many countries are acquired for a single product, which is produced in yet another country. The product is shipped off to still another country for processing, and then sold to a new group of countries for all sorts of purposes, including re-export. Devaluating a currency is unlikely to have the desired effect.

And so the trade wars begin.

As countries create obstacles to free trade, economic growth slows worldwide and imported goods become more expensive, causing inflation. In an inflationary economy, investors move into commodities to protect themselves, which leads to further inflation. It’s all bad.

It makes no more sense now to provoke the Chinese than it did in June when Congress last floated the idea. Not only does China own a huge amount of our debt, China is our third largest export market. U.S. auto manufacturers have sent 57,000 cars to China so far this year. That’s good news for struggling American car companies.

Sen. Charles Schumer (D-NY) has vowed to push for a vote on the Chinese smackdown legislation in the Senate’s lame-duck session after the election. But once the votes are cast on Nov. 2^nd, he may well lose interest.

And assuming U.S. politicians don’t take their posturing too far, China will probably continue to allow the yuan to rise very gradually.