Sunday, September 25, 2011

Senators Blindly Promising to "Get Tough" on China's Currency

The US Senate is poised to take up the issue of China's currency policies, and nothing - certainly not some measly little facts that totally undermine the issue's relevance - is going to slow the legislation down.  You see, in today's Senate - one that hasn't passed a budget in almost 900 days - politics trumps reality.  Every single time.

Last Thursday, a bi-partisan group of Senators, led by Sens. Chuck Schumer (D-NY) and Sherrod Brown (D-OH) announced their much-anticipated legislation targeting China's currency policies:
Senators Charles Schumer of New York and Sherrod Brown of Ohio, both Democrats, urged support for legislation pushing China to raise the value of its currency as a way to stem U.S. job losses.

China’s currency policies cost more than 2.8 million U.S. jobs since 2001, the lawmakers said today at a Washington news conference. The legislation would let U.S. companies seek duties on imports from China to compensate for the effect of a weak yuan, which lawmakers said gives Chinese companies an unfair advantage against U.S. manufacturers.

“They get away with economic murder,” Schumer told reporters. “We are fed up; we are not going to take it anymore.” 
Schumer proposed similar measures in each of the past six years. None has received a Senate vote. The bill also is supported by Democratic Senators Robert Casey of Pennsylvania and Debbie Stabenow of Michigan, and Republicans Lindsey Graham of South Carolina, Richard Burr of North Carolina and Jeff Sessions of Alabama.
So to recap the Senators' argument: China's undervalued currency has eliminated 2.8 million US jobs, and these brave Senators want to empower US companies to seek new tariffs on Chinese imports in order to force China's hand.  Sounds almost plausible, but there's one big problem: every single "fact" in that previous sentence is dubious.

At best.

First, the employment study that the Senators cited - by the union-run and union-funded Economic Policy Institute - is total economic bunk.  I've already been over this fact several times, citing to myriad economists who have explained that EPI's methodology, which simply ties the US trade deficit to American job losses, is utter poppycock.  Cato's Dan Ikenson elaborated on this little fact last week, showing how EPI's so-called "findings" fly in the face of both economic theory and reality:
As the chart below (which is based on easily verifiable figures published in the Economic Report of the President) reveals, the trade deficit and job creation appear to be positively correlated. When the deficit rises, employment increases; when the deficit shrinks, employment declines. So, right off the bat, a central premise of [EPI's Robert] Scott’s analysis is in doubt.... 

Last month, the U.S. International Trade Commission published its seventh update to the “The Economic Effects of Significant U.S. Import Restraints” study, which contains a special section on global supply chains. On page xv of the executive summary is a table that not only raises more serious doubts about EPI’s methodology, but should put to rest once and for all the hyperbole employed and anxiety caused by alarmist public relations campaigns and the politicians they serve.

Table ES.4 of that study indicates that there is more U.S. valued added (U.S. labor, material, and overhead) in U.S. imports than there is Chinese valued added in U.S. imports. Specifically, 8.3 percent of the value of U.S. imports (about $160 billion last year) is U.S. value, while 7.7 percent of the value of U.S. imports is Chinese value added. EPI’s methodology does not account for the U.S. jobs associated with the U.S. value added in U.S. imports.

Furthermore, that same table reveals that U.S. value added accounts for 89 percent of total U.S. consumption (a figure that confirms the findings in a recent San Francisco Federal Reserve study), which means that foreign value-added accounts for just 11 percent of U.S. consumption, making the United States a fairly closed economy—or at least, a relatively non-integrated economy. And China? Well, China only accounts for a measly 0.9 percent of the goods and services consumed in the United States. So, if 2.8 million U.S. jobs were lost to a country that produces less than one percent of what Americans consume, I say its about time we shed those highly inefficient jobs that have been a drag on the U.S. economy. The fact is, however, that 2.8 million is a fiction....

Yes, the 2.8 million job loss figure is a fiction, concocted to support political talking points and a narrow agenda that distract the public from the real problems that ail our economy. Some Chinese government policies are genuine causes for concern, worthy of efforts to resolve, but we limit our capacity to address the real problems effectively when every last gripe becomes a call to arms.
In short, the EPI study is totally worthless for anything other than shameless political demagoguery.  Fortunately for EPI, that just happens to be a certain New York Senator's specialty!  Unfortunately for the rest of us, most reporters hired to cover that Senator's currency shenanigans don't do their homework and instead treat the "study" cited by Schumer (and others) as gospel.

Shame on them.

The second problem with the Senator's argument is that most US companies aren't begging for relief from China's currency policies.  Indeed, a lot of them are literally begging the Senate to back off the currency issue and focus on other, real bilateral trade issues.  For example, just last week over 50 trade associations, representing hundreds (if not more) US companies, sent a letter to Senate leaders asking them to drop the tough currency talk.  The full letter is available online and definitely worth reading, but here are some key excerpts:
We agree with many in Congress and the Administration that China needs a yuan exchange rate that responds to trade flows and that China should move steadily towards a market-determined exchange rate.

However, unilateral legislation on this issue would be counterproductive not only to the goals related to China’s exchange rate that we all share, but also to our nation’s broader objectives of addressing the many and growing challenges that we face in China.

Legislation that would increase tariffs on imports from China is unlikely to create any incentive for China to move expeditiously to modify its exchange policies. Rather, it would likely have the opposite effect and result in retaliation against U.S. exports into China – currently the fastest-growing market for U.S. exports.

We urge you to oppose currency legislation and instead work with and vigorously call on the Administration to develop a robust bilateral and multilateral approach to achieve tangible results, not only on China’s exchange-rate policies, but also on other Chinese policies that are harming American economic interests.
The business group letter also highlights the third problem with Schumer's plan: unilateral US action (i.e., tariffs) against China are unlikely to convince the Chinese government to do anything except resist further Yuan appreciation and retaliate against US exports and companies.  As I said earlier this month about Mitt Romney's misguided plan to aggressively target China's currency via Executive Order:
The idea that the Chinese government would just roll over and concede "defeat" in the face of President Trump[Romney]'s big, macho tariff is absurd.  First, Trump[Romney] fails to grasp that the Chinese government would never, ever do anything that makes it appear weak in the face of American aggression.  Instead, retaliation, not concession, is the far more likely reaction (just as China did when President Obama imposed those tire tariffs), and such sinophobic chest-thumping would likely retard, not quicken, the gradual appreciation of the yuan that China needs to undertake.  Second, China's not nearly as dependent on the US market as Trump[Romney] seems to think.  The EU is now China's biggest export market, and Chinese exports to the US represent under 30% of China's exports to its top 10 export destinations.  So while the US market is big and important, China has other options.  Third, China couldn't rapidly and dramatically appreciate its currency even if it wanted to because any such move would implode the Chinese - and by extension, global - economy.
So the tariffs probably won't change China's behavior, and they definitely will harm US companies and consumers.  Thanks for nothing, Senators.

Finally, it's far from clear that the Yuan remains significantly undervalued against the US dollar.  I've already discussed this inconvenient truth repeatedly, and news last Friday about a massive selloff of Yuan further undermines the conventional wisdom regarding China's currency:
A rush for safe investment havens led to an unexpected drop in the value of the Chinese yuan traded outside the mainland, as global investors eschewed a bet on a currency widely seen as undervalued for the comfort of the U.S. dollar and the Japanese yen. The move will have little effect on yuan as a whole because Beijing still tightly controls the currency. But it offers an example of the uncertainties China could face as it moves in fits and starts to loosen its restrictions on the yuan and give it a more central global role.

The drop took place mostly in Hong Kong, a Chinese city that operates under its own set of laws and the only place where the yuan can be traded outside the Chinese mainland. Chinese officials over the past year have transformed the city into a laboratory for yuan liberalization, allowing everything from the issuance of yuan-denominated bonds to yuan-trade settlement to yuan accounts for individual investors.

Until this week, the Hong Kong-traded yuan had remained broadly in line with the official yuan trading range. But market turmoil Thursday and Friday prompted the Hong Kong price to slump at one point to a discount of as much as 2.5% to the mainland yuan, the biggest gap since China began relaxing its currency restrictions about a year ago. The yuan on the mainland trades in a tight band because of Beijing's restrictions on its currency.

The discrepancy between Hong Kong-traded yuan and mainland yuan, known as of offshore market and the onshore market, respectively, later narrowed somewhat but remained high by historical standards, and late Friday traded at 6.49 yuan to the dollar in Hong Kong, compared with 6.39 yuan in the mainland. The moves fly in the face of currency-market conventional wisdom, which holds that the yuan is set to rise against the U.S. dollar as China soaks up capital and trade flows.

The selling pressure overwhelmed a facility set up by China to sell yuan at the mainland rate, which on Friday was offering investors more dollars for their yuan. Late in the day, Bank of China Ltd.'s Hong Kong arm, the designated clearing bank for the Hong Kong market, said it would temporarily stop buying yuan used for trade settlement as its quarterly quota for such transactions was full....

Market turmoil also roiled the market for yuan nondeliverable forwards, which are offshore derivatives that track the value of the yuan but can't be exchanged for the currency. The dollar one-year forward on Friday was bid as high as 6.47 yuan against the domestic spot rate of 6.39 yuan, implying expectations of a 1.3% yuan fall over the coming months.

Until now, global investors have largely adopted a strategy of shorting the dollar for the yuan on expectations that Beijing would continue to allow its currency to rise. In fact, desire for yuan offshore has caused the Chinese currency traded in Hong Kong to boast a premium over its mainland counterpart at most times.

Now, worries of an economic recession around the globe and a Greek debt default are driving investors back into the relatively safety of the U.S. dollar, leading many investors to sell yuan and other currencies for dollars.
For those of you (like me) who aren't currency experts, investors don't typically flee an "undervalued" Yuan for an "overvalued" Dollar.

So to summarize: the Senators are using a debunked economic study to justify their targeting a problem that might not even exist with a strategy that will never work on behalf of a constituency that doesn't want their help.

But other than that....

1 comment:

Frank in midtown said...

I was wondering, do you understand the mechanism of a currency peg? Currency pegs are negative carry-trades (you take money out of a fast growing economy and re-invest it in a slower growing economy.) The CIC owns lots of US Treas., but the CIC also has issued bonds at a higher coupon than the U.S. Treas. bonds it owns. This negative carry means that the CIC will eventually have to run out and buy more dollars. The press usually calls them "currency meltdowns."