Good Thing We Ignored Paul Krugman, Part 632

A couple days ago, Paul Krugman made a rather quiet admission: contrary to his previous histrionics, China's currency ain't a big deal anymore:

In 2010 an undervalued renminbi was a significant drag on advanced economies, including the United States. Since then, however, two big things have happened: relatively high inflation in China, and some appreciation of the renminbi against the dollar. As a result, the real exchange rate of China against the United States (based on consumer prices), has appreciated significantly:

At the same time. China’s surplus has come way down:

So this is an odd time to be making confrontation over China’s currency a centerpiece of your economic policy — unless, of course, it’s just bluster aimed at making voters think you’re tough.

I have no idea whether Mitt Romney's misguided stance on China's currency or the aforementioned facts really caused Krugman's views to change, but that's not important for tonight's purposes.  Instead, I just want to gloat examine this great transformation and the implications of Krugman's previous advice on the China currency issue.

As you may recall, in 2010 grousing about China's currency was pretty much a monthly affair for Krugman's New York Times column.  But he not only would rage about the dangerous "global imbalances" caused by Chna's currency, but also would demand that the United States adopt a severly protectionist stance in order to remedy the "problem":

In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. At this point, it’s hard to see China changing its policies unless faced with the threat of similar action — except that this time the surcharge would have to be much larger, say 25 percent.

I don’t propose this turn to policy hardball lightly. But Chinese currency policy is adding materially to the world’s economic problems at a time when those problems are already very severe. It’s time to take a stand.

When Krugman made this proposal, I and a host of other (smarter) people took to the interwebs to explain just how ridiculously awful the idea of an across-the-board 25% "currency tariff" was from a historical, legal and economic perspective.  We repeated those criticisms when he later expressed support for Senate legislation (which followed unfortunate passage of an almost-identical House bill) that would have directed the US Department of Commerce to treat currency undervaluation as a countervailable export subsidy, thereby opening the door to countervailing duties on Chinese - and other! - imports.  We even went so far as to explain that, even assuming that Krugman and others were correct that China's currency was horribly manipulated and causing dangerous global imbalances, basic economics dictates that the whole thing would work itself out, and that harmful protectionist tariffs were most definitely NOT needed to solve the so-called "problem."

So here's my basic question for Dr. Krugman - a man who, by the way, used to be one of the pre-eminent advocates for free trade:

Aren't you just thrilled that Congress didn't take your advice and open the permanent, pandora's box of currency protectionism to address a "problem" that, as you now freely admit, has fixed itself in under 2 years?

Seriously, just think of what would've happened if the Senate had bowed to Krugman's demands and passed the currency/CVD bill: we'd very likely have this messy new protectionist law on the books, leading to lord-only-knows-how-much litigation, economic harm and diplomatic tension between two of the world's biggest economies. 

Instead, the only thing damaged is Dr. Krugman's free trade and economic reputation.

Boy, did we dodge a bullet!

Countervailing Calamity: The Pandora's Box of Currency Protectionism

At tonight's much-anticipated Presidential Debate, it's quite possible that the issue of China's currency will be raised by the debate moderator or one of the candidates.  I've spilled a lot of virtual ink at this blog about trade and currency issues and the legal problems with certain politicians' desire to impose countervailing duties (CVDs) on Chinese imports due to alleged currency manipulation or undervaluation.  But my forthcoming paper, "Countervailing Calamity: How to Stop the Global Subsidies Race," zeroes in on one of the most troublesome legal and economic issues surrounding the whole currency/CVD debate: it opens the door to some serious protectionism, and not just against China. 

To understand why this is requires some quick background on how a subsidy is determined to exist under the US countervailing duty law.  As I first note in the paper, "A subsidy is defined as a 'financial contribution' by a 'government' or 'public body' that confers a 'benefit' on the recipient."  While that definition seems pretty harmless, it would be, except for the fact that the US Department of Commerce does some pretty, ahem, creative things to magically find a subsidy "benefit" where none might actually exist:

Existing U.S. law gives DOC ample discretion to measure the benefit (and thus the magnitude of an alleged subsidy), including the use of external subsidy benchmarks that have no relation to the domestic market at issue. This can lead to the imposition of CVDs that exceed the actual level of subsidization in the market and thus penalize U.S. importers and consumers rather than offset the injurious subsidies at issue. As noted above, in cases of grants or tax breaks, the calculation of benefits is straightforward—it is the amount of the grant or the tax revenue foregone. However, in many other cases (particularly for government-provided loans, goods, or services), DOC resorts to external benchmarks from other markets or world-market prices, where it determines that domestic interest rates or prices—the preferred benchmark—are unusable. These benchmarks often have little to do with the unique comparative advantages of the domestic market at issue and are expressly preferred over constructed benchmarks (e.g., cost of production plus profit) based on prevailing market conditions in the country of provision.

As a result of this policy, DOC has used external benchmarks to determine the magnitude of many subsidies, including those related to government-provided loans, land, water, stumpage (wood), and metals. The calculations resulting from DOC’s use of external benchmarks have produced subsidy amounts that often have very little to do with the market value of the actual government-provided loan or good/service at issue and negate the investigated countries’ natural comparative advantages. Thus, final CVD rates for these subsidies are often much larger than the actual benefit, if any, that an exporter has received from the government transaction.

DOC’s recent CVD investigation of aluminum extrusions from China provides an example of the difficulties involved with external benchmarks. In that case, DOC used prices for raw aluminum from the London Metal Exchange and prices for land from Thailand, rather than in-country prices for these goods. Although one could reasonably argue that London Metal Exchange aluminum prices are roughly comparable to those in China because aluminum is a globally traded commodity, no such reason applies for something so uniquely country-specific as land. Thus, any “land subsidy” found to exist in this case has little relationship to the actual subsidy, if any, conferred by the Chinese government.

Ok, so how does this all relate to currency?  Well (emphasis mine)...

Legislative proposals to address “currency misalignment” would exacerbate existing concerns because they would authorize DOC to calculate the amount of a currency’s undervaluation by using a basket of other comparable countries’ currencies as a surrogate for what that currency’s value should actually be in an uncontrolled market. Such a market benchmark would not reflect the many unique circumstances surrounding the value of a nation’s currency. Moreover, because such legislation is not limited to China (such limitation would violate WTO non-discrimination rules) and because many other countries engage in similar forms of currency management, currency/CVD proposals would open the door to copycat cases against imports from many countries other than China. For example, a recent study by the Peterson Institute alleged that counties like Switzerland, Malaysia, Algeria, Russia, and others engage in “currency manipulation.” Should a currency/CVD proposal become law, there would be nothing to stop domestic industries and unions—and their lawyers—from pursuing CVD cases against all of these countries, using external subsidy benchmarks to find a benefit where none might actually exist.

In short, once our politicians open the door to a currency tariff, there will be very little to stop protection-seeking unions, industries and (of course) their crafty lawyers from asking the US government to impose duties on imports from many other countries.  And they have plenty of empirical support (whether I agree with it or not!) from well-respected think tanks to make those scary arguments. 

Oh, goody.

And, oh by the way, after the recent QE3 announcement here in the states, several countries (most notably Brazil) have angrily accused the US government of - you guessed it - devaluing the dollar to boost exports.  Most of these countries also have CVD laws too, you know.

Those currency CVD proposals ain't looking so hot now, eh?

More tidbits from my new paper are available here, if you're interested.

2012 GOP Platform on Trade: the Good, the Bad, and the Really Ugly

The Republican Party has released its 2012 Platform, and it's pretty much what you'd expect given the past few months of campaign and congressional rhetoric: it mostly supports free trade, yet does so in a mercantilist way and contains some pretty harsh - and indeed protectionist - words for today's trade bogeyman, China.  In fact, the platform seems like it was almost entirely lifted from Gov. Mitt Romney's 2011 economic plan, for the better and the worse.  Although there are various trade-related elements throughout the platform, the main "international trade" section can be found on pages 6-7 and I'll focus on it tonight:

International Trade:
More American Jobs, Higher Wages, and A Better Standard of Living

International trade is crucial for our economy. It means more American jobs, higher wages, and a better standard of living. Every $1 billion in additional U.S. exports means another 5,000 jobs here at home. The Free Trade Agreements negotiated with friendly democracies since President Reagan’s trailblazing pact with Israel in 1985 facilitated the creation of nearly ten million jobs supported by our exports. That record makes all the more deplorable the current Administration’s slowness in completing agreements begun by its predecessor and its failure to pursue any new trade agreements with friendly nations.

This worldwide explosion of trade has had a downside, however, as some governments have used a variety of unfair means to limit American access to their markets while stealing our designs, patents, brands, know-how, and technology—the “intellectual property” that drives innovation. The chief offender is China, which has built up its economy in part by piggybacking onto Western technological advances, manipulates its currency to the disadvantage of American exporters, excludes American products from government purchases, subsidizes Chinese companies to give them a commercial advantage, and invents regulations and standards designed to keep out foreign competition. The current Administration’s way of dealing with all these violations of world trade standards has been a virtual surrender.

Republicans understand that you can succeed in a negotiation only if you are willing to walk away from it. Thus, a Republican President will insist on full parity in trade with China and stand ready to impose countervailing duties if China fails to amend its currency policies. Commercial discrimination will be met in kind. Counterfeit goods will be aggressively kept out of the country. Victimized private firms will be encouraged to raise claims in both U.S. courts and at the World Trade Organization. Punitive measures will be imposed on foreign firms that misappropriate American technology and intellectual property. Until China abides by the WTO’s Government Procurement Agreement, the United States government will end procurement of Chinese goods and services.

Because American workers have shown that, on a truly level playing field, they can surpass the competition in international trade, we call for the restoration of presidential Trade Promotion Authority. It will ensure up or down votes in Congress on any new trade agreements, without meddling by special interests. A Republican President will complete negotiations for a Trans-Pacific Partnership to open rapidly developing Asian markets to U.S. products. Beyond that, we envision a worldwide multilateral agreement among nations committed to the principles of open markets, what has been called a “Reagan Economic Zone,” in which free trade will truly be fair trade for all concerned.

I've been over most of these ideas before, so there's no need to get long-winded tonight.  Instead, here's a quick summary of the good, the bad and the ugly in the GOP platform's international trade section:

The Good. The platform expresses unequivocal support for international trade and free trade agreements.  Especially noteworthy is (i) formal party support for the Trans-Pacific Partnership - something we've suspected but not really heard from the GOP's top dogs; and (ii) a loud call for restoration of Trade Promotion Authority - an absolutely critical legal tool for the President's ability to effectively negotiate new trade deals.  Although I'll start complaining in just a second, the GOP's embrace of international trade is definitely a good thing, especially given the economic anxiety out there right now and the strong anti-outsourcing and anti-trade stuff we've been hearing from most Democrats.  Maybe the Dem Platform will surprise us and not contain similar protectionist positions this time around, but until then, the GOP remains the better party when it comes to public support for good trade policy.

The Bad.  The platform continues the failed approach of selling free trade through a single-minded focus on exports and reciprocal trade (i.e., only opening our market if others open theirs).  As I've repeatedly discussed, this strategy is not only economically ignorant, but it also undermines public support for free trade by reinforcing the erroneous notion that imports - and by extension the US trade deficit - are somehow bad for the US economy.  The platform also errs in its support for Romney's "Reagan Economic Zone" - a silly idea from a practical perspective (I've yet to read serious, apolitical trade policy expert express even lukewarm support) and one that implicitly abandons the existing multilateral negotiating framework at the WTO.  That, in my opinion, is a serious mistake - the WTO is and will remain the only real mechanism for broadbased, multilateral trade liberalization, and any alternatives are dangerous non-starters.  The GOP certainly isn't abandoning the WTO altogether - the text above promotes the use of WTO dispute settlement, and the platform on page 49 supports Permanent Normal Trade Relations with Russia in order to reap the benefits of Russia's WTO accession - but the Reagan Zone strongly implies that the GOP no longer sees multilateral negotiations through the WTO as viable.  And that, in my opinion, is a mistake, regardless of the big mess that is the Doha Round.

The Ugly.  I guess it shouldn't be a surprise, but it's really a shame that America's "free market" party has warmly embraced Romney's zealous contempt for all things China trade-related.  This includes support for (i) countervailing duties on Chinese imports due to currency manipulation; (ii) mysterious "punitive measures" on foreign firms found engaging in IPR theft; and (iii) support for a "Buy AmericanAnything-But-Chinese" procurement policy.  Leaving aside for the moment the fact that each of these proposals raises serious legal and practical concerns (see, e.g., here on currency; there's not really a vehicle under US law for the second; and the third could violate WTO rules if it singled out China), there are much bigger problems with such talk: 

• First, the scary chest-thumping overshadows far more legitimate gripes about bad Chinese trade policies (like subsidies and IPR enforcement).  When you're screaming about attacking imports and investment, people tend not to notice your more subtle gripes about real problems in the Chinese market. 

• Second, and more importantly, these proposals expressly condone self-destructive retaliatory protectionism that defies economic sense and free market principles.  As I've repeatedly warned, there is absolutely no reason why such "logic" couldn't be applied to other "offending" countries, and the protectionist slope is very, very slippery.  Saying "we only meant it for China" is likely not going to serve as an adequate defense when the well-funded protectionists come knocking on the White House door.  And, by empowering these anti-trade forces, such proposals also won't help improve tepid American support for free trade.  In short, Pandora's Box has been opened, and it remains to be seen whether Republicans can control the nastiness inside.  The Democrats - who once supported things like NAFTA, China trade and the WTO (see, e.g., Bill Clinton) - sure couldn't.

Granted, each of the GOP's China trade proposals allows for ample wiggle-room, and it's very likely that a President Romney would pursue a much less aggressive approach (indeed, the platform later on page 49 states that the GOP "welcome[s] the increase in trade and education alliances with the U.S. and the opening of Chinese markets to American companies").  Regardless, "Commercial discrimination will be met in kind" is a recipe for heightened protectionism and possibly a trade war, not a responsible, economically and legally sound policy from the supposed "adult in the room" on US international trade policy and politics.  And the sign that such rhetoric - in GOP's defining policy document, no less - sends to the rest of the world is nothing short of embarrassing.  The only bright side for Republicans, I guess, is that the Democrats' platform promises to be even worse.

Hooray, lesser of two evils!

More to come, I'm sure.

On China Trade, Paul Ryan Toes the (New, Fake) Company Line

Well, that certainly didn't take long:

In his first remarks touching foreign policy since becoming Mitt Romney's running mate, Paul Ryan had tough words for China in this manufacturing-heavy battleground state.

"They steal our intellectual property rights. They block access to their markets. They manipulate their currency."

He continued, "President Obama promised he would stop these practices. He said he’d go to the mat with China. Instead, they’re treating him like a doormat. We’re not going to let that happen. Mitt Romney and I are going to crackdown on China cheating. We’re going to make sure that trade works for Americans."

Sigh.  Although I'm certainly not a fan of Ryan's comments, they're utterly unsurprising given that China-bashing has been a central plank of Romney's economic platform for almost a year now, and that his new running mate has hardly been a strong and outspoken champion for trade liberalization during his twelve years in Congress.  (Something I acknowledged again last night.)  However, as I noted on Sunday, Rep. Ryan has a pretty good voting record on China trade, having approved Permanent Normal Trade Relations for China back in 2000 (as part of its WTO accession) and, more importantly, opposing a 2010 bill that would have authorized the Department of Commerce to treat "currency manipulation" as a countervailable subsidy - virtually identical to one of the things that Governor Romney promises to do on "Day 1" of his Presidency.

A smart reporter was quick to note this blatant conflict, to which the Romney campaign responded with a classic bit of political non-speak:

The Romney campaign responds that the president already has sufficient authority to act on China's currency manipulation, and a Romney-Ryan administration would do exactly that.

“Like Gov. Romney, Congressman Ryan believes America must take aggressive action to confront nations like China that cheat on trade," says spokesman Brendan Buck. "He believes this can be done most effectively when the president has the freedom to take appropriate action, and that we need a president like Gov. Romney who is committed to doing just that instead one like President Obama who has shown he won’t.”

Umm, yeah, if you can make sense of Mr. Buck's soundbite, please let me know because I certainly can't.  However, because campaign journalists don't understand the basics of US trade law, it appears he got away with it... for now, at least.  That said, I'd be remiss not to counter the paraphrased notion above that President Romney could unilaterally label China a currency manipulator or impose duties on Chinese products on his first day in office.  As I explained back when Romney's big plan first landed:

First... Treasury's assessment and designation of foreign countries as "currency manipulators" is conducted pursuant to US law (22 U.S.C. § 5301-5306), which defines "currency manipulators" as countries that "manipulate the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustment or gaining unfair competitive advantage in international trade.” Treasury's assessment must be done in consultation with the IMF and pursuant to pretty strict guidelines. In short, the President can't just tell Treasury to designate a country a "currency manipulator," and he/she certainly can't do it publicly via Executive Order (as Romney's plan promises). To do so would not only violate the letter of the law, but also destroy the Treasury report's credibility.

Second, the President can't just instruct the Commerce Department to begin imposing countervailing duties on Chinese goods. Pursuant to US trade law and regulations, the imposition of countervailing duties on imports requires (i) a petition from an affected industry or self-initiation by Commerce (something that never happens) requesting remedial tariffs on a discrete subset of allegedly subsidized imports; (ii) preliminary and final findings, based on extensive evidence (including rebuttal from Chinese producers, US importers and the Chinese government), of that said imports are being subsidized; and (iii) preliminary and final findings by the non-partisan International Trade Commission that said imports are injuring the US industry. Each of these steps is required by US law and WTO rules. So Romney's plan to, on the very first day of his presidency, just start imposing CVDs on Chinese imports would be in direct conflict with both US law and the United States' WTO obligations.

On the second point, it's also important to note that, even a more subtle approach which simply directed Commerce to begin treating "currency manipulation" as a countervailable subsidy would raise red flags because the Department has repeatedly found that currency policies do not meet the definition of a countervailable subsidy under US law.  (This is why anti-China protectionists have been begging for China currency/CVD legislation for the past several years!)  Now, yes, DOC can theoretically change its policy where it has a reasonable basis to do so, but it is extremely unlikely that "Presidential pressure" would qualify as such (and that still wouldn't obviate some serious WTO concerns).  And, anyway, is the Romney campaign really trying to say that its big China trade plan is to strong-arm the Commerce Department into reversing its longstanding policy of not treating currency undervaluation as a countervailable subsidy?  I doubt it.

But, of course, no one in the press pool or on the Obama campaign will ever get into these thorny issues with the Romney/Ryan team, so this is all just me ranting into the interwebs academic anyway.  And, like I've said a few times now, there are good reasons (Rep. Ryan's pro-trade votes being one of them) to expect that President Romney would, like President Obama before him, ditch the China protectionism the minute he arrived in the Oval Office.

But that doesn't mean I have to sit back and enjoy it.

Silver Linings...

Readers of this blog know that, despite my support for many Republican politicians' free market proposals, I haven't been shy in my criticism of Mitt Romney's stance on US-China trade.  A new "infographic" from Team Mitt makes clear that his sinophobic chest-thumping was not merely a primary play to fans of The Donald, but instead will be a central theme and distinguishing element of Romney's general election campaign (h/t Ben Domenech):

Ugh.  I will not repeat the reasons why I'm not a fan of this campaign strategy (go here and here for that), but I may have discovered the bright-side to the Governor's distressing China protectionism:

It's producing a sudden surge of media skepticism regarding currency hawks' claims.

You see, it used to be that only principled, free-market publications like the Wall Street Journal and the Financial Times would actually spare the ink to explain why well-oiled politicians' anti-China proposals lacked seriousness.  Now, however, a quick Google search reveals overtly skeptical pieces of Romney's China stance from Bloomberg (multiple, actually), the New York Times, the LA Times, the Seattle Times, the New Republic and several other "mainstream" outlets.

Perhaps the most blatant and extensive example of this new scrutiny, however, comes from Reuters today in an "insight" column focusing on a time "when Romney wasn't so tough on China."  I couldn't care less about that time (Ooooh, he did business with China at Bain! Oooh, he courted China when he was in charge of the Olympics!  Zzzzzzzzz), but what did get me excited (stop laughing) were the following excellent passages on the, you know, actual facts about China's currency policies, the US economy and certain politicians' and pundits' claims that forceful anti-China actions (read: tariffs) are the only solution to the Red Menace's pernicious currency manipulation:

Romney and his campaign have often talked about how three companies that Bain invested in during this period - the Staples Inc, Sports Authority Inc and Domino's Pizza Inc chains - have gone on to create more than 100,000 jobs combined.

What he does not discuss is the role China is playing in these businesses. For example, of 80 items randomly chosen in a Sports Authority store in Washington, D.C., earlier this month, about two-thirds were Chinese produced - including tennis balls, bikes and boxing gloves.

At a Staples outlet in New York, the figure was more like 40 percent, including staplers, glue and rulers. The percentage may be bigger on a sales basis because a lot of the higher-priced goods, like computers and other electronic gear, come from China.

To be sure, it is not clear how much China-sourcing the companies did when Romney was at Bain. Staples and Sports Authority had no comment.

There is nothing unusual about U.S. retailers getting their wares made in China; the biggest, including Wal-Mart Stores Inc, do so.

But if China revalues its currency, companies like Staples would face higher costs and might have to raise prices. The retailer might also look for cheaper alternatives - it already produces a significant number of products in countries such as Mexico and Egypt.

A stronger yuan could increase dollar revenues from China for companies like Domino's, which sells there, but any major trade tensions with Beijing could hold back the expansion of U.S. companies in the country....

The saber-rattling from Romney has worried business executives. Behind closed doors, some grumble that he is wasting political capital on the currency question when there are bigger problems to resolve with China, such as access to its financial markets and protecting U.S. companies' intellectual property.

"Given his background, many of us had assumed he would take a broader view," said Erin Ennis, vice president of the U.S.-China Business Council, which represents about 250 companies that do business with China, including Dow Chemical Co, Ford Motor Co and Apple Inc.

Thomas Donohue, president of America's largest business lobby, the U.S. Chamber of Commerce, said the yuan's rise in recent years had taken away the case for declaring China a currency manipulator. "You can't make that argument anymore," he said in April.

The yuan has appreciated nearly 30 percent since China broke its peg to the U.S. dollar in 2005. When adjusted for inflation, it is up about 40 percent against the greenback, and China labor and other manufacturing costs have climbed.

Talks between Washington and Beijing about adjusting the yuan's value are already under way and have shown some progress.

But still, Romney's declaration of China as a currency manipulator would carry risks. If the United States' third-largest export market feels it is being unfairly targeted, it could fight back with more than just words.

In 2009, when the Obama administration imposed tariffs on low-end tires from China, Beijing immediately launched a formal anti-dumping probe of American exports of chicken and auto parts.

The World Trade Organization has since ruled that the United States is entitled to impose the extra duties on Chinese tires. The two countries are still fighting over the chicken parts, and new disputes have arisen over solar panels, wind turbine towers and rare earths.

With the world's two largest economies tightly intertwined and Washington increasingly seeking Beijing's help on diplomatic issues, the fear is that China could not only slow the appreciation of the yuan but also retaliate in other areas important to the United States, such as U.S. farm exports and Western sanctions against Iran.

If these passages sound familiar, they should: they're pretty much identical to many of the arguments that we (sane) free traders have made over the past few years in opposing any sort of aggressive US protectionism based on alleged Chinese currency manipulation:

• Adverse effects on US consumers (including many companies and their workers) caused by any big appreciation of the RMB? Check.

• Trade diversion to other low-cost markets rather than increased US manufacturing as Chinese imports get more expensive? Check?

• Context of the significant appreciation of China's currency against the dollar, as well as increases in domestic labor costs and export prices, over the last few years? Check.

• Potential Chinese retaliation against US investors and exporters in response to any US unilateralism? Check.

• Questioning the strategic logic of any US threats (i.e., that China might actually slow RMB appreciation if it feels its being strong-armed by the United States)? Check.

Impressive.  Indeed, I think the only thing separating Reuters' skepticism from my own is the legal dubiousness of any currency-related trade measures like countervailing duties.  But as impressive as this new article and its brethren are, I don't seem to remember similar analyses over the last few years when candidate-turned-President Obama routinely groused about Chinese currency manipulation and its devastating effects on the US manufacturing sector.  Sure, there was the occasional news report on Chinese currency appreciation or some other insular event that proved free traders' points about the pointlessness of China currency antagonism, but nothing - nothing - like the column above.  (The only thing I could find was this 2011 Washington Post editorial, and it blames Congress and never explains the flipside of RMB appreciation.)

So, nice work, Governor Romney: you've apparently opened the media's eyes to the myriad flaws in currency hawks' plans.  If that was your secret plan all along, I'm impressed. (Again, stop laughing.)

And, hey, who knows: at this rate maybe Reuters' detailed legal analysis will arrive in late October when they're really desperate.

(P.s. And before you start thinking that the China currency issue puts a +1 in President Obama's column, here's his top political adviser strongly implying that his boss is the real "trade warrior" in the 2012 race.  Boy, I sure can't wait for the two candidates to duke it out over that inglorious distinction.  Sigh.)

Is Missing American Trade Leadership Beginning to Bear Protectionist Fruit? (Hint: Kinda Looks Like It)

Over the past few years, I and several other US trade-watchers have lamented the United States' dwindling leadership on global trade and economic issues and warned of that trend's troubling potential ramifications.  It appears that at least one of our breathless predictions may finally be coming true.  Starting in mid-2009 - when it became depressingly clear that the Obama administration viewed trade in mostly political terms and thus would not be advancing a robust, proactive free trade agenda - we free traders expressed grave concern that US recalcitrance could harm not only US companies and workers, but also the entire global free trade system.  As I explained in a 2009 oped urging the President to adopt a robust pro-trade agenda (as outlined in this contemporary Cato Institute paper):

Since the 1940s, the US has led the charge to remove international barriers to goods, services and investment. The result: a global trade explosion that has enriched American families, spurred innovation, enhanced our security and helped millions escape poverty. Every US president since Herbert Hoover has championed free trade because of its proven benefits....

Because of today's rules-based multilateral trading system and the interdependence of global markets, US fecklessness on trade shouldn't lead to devastating protectionism akin to the Smoot-Hawley-induced tariff wars of the 1930s. But it's still a problem. In 2008, global trade contracted for the first time since 1982, and protectionist pressures abound. The WTO's Doha Round is comatose, even though an ambitious deal could inject US$2 trillion into the reeling global economy. Considering the US has steered every major trade initiative in modern history, any chance for significant progress on trade will disappear without strong American leadership - in word and deed.

Since that time, the President has clearly not taken free traders' advice.  The WTO's Doha Round is dead, despite a pretty good opportunity to force the issue back in late 2010.  The Obama administration took three years to implement already-dusty FTAs with Korea, Panama and Colombia and actually insisted on watering the deals down with new protectionist provisions in order to finally agree to move them.  And while countries around the world are signing new trade agreements left and right, we've signed exactly zero and have eschewed important new participants and demanded absurd domestic protectionism in the one agreement that we are negotiating (the TPP).  Meanwhile, on the home front the President has publicly championed mercantilism, as his minions quietly pursued myriad efforts to restrict import competition and consumer freedom, embraced competitive devaluation and maintained WTO-illegal policies (while publicly denouncing protectionism, of course).

Pretty stark when you lay it all out like that, huh?

Despite this depressing state of affairs, it did not appear that the United States' diversion from its long free trade legacy had resulted in a tangible increase in global protectionism (although the death of Doha certainly isn't a good thing).  Unfortunately, a new blog post from the FT's Alan Beattie indicates that those chickens may finally be coming home to roost:

One of the very few bright spots in governments’ generally grim recent performance of managing the world economy has been that trade protectionism, rampant during the Great Depression, has been relatively absent.

That may no longer be the case. The WTO, fairly sanguine about the use of trade barriers over the past few years, warns today that things are getting worrying. The EU made a similar point yesterday. And this monitoring service has been pointing out for a long time that a lot of the new forms of protectionism aren’t counted under the traditional categories, thanks to gaping holes in international trade law.

After glancing at the bi-partisan protectionism on display in the 2012 US presidential campaign, Beattie concludes that, on the global trade stage, "things are looking scarier than they have for a while."  I'm certainly inclined to agree, and one need only look South to Brazil's frighteningly rapid transition from once-burgeoning free trade star to economically-stagnant, unabashed protectionist to see a scary example of why.

And while I agree with Beattie that the world still isn't likely to descend into a 1930s-style trade war - we can thank the WTO and the proliferation of free market economics for that - the rising specter of global protectionism is undoubtedly distressing.

And, of course, it has risen just as America's free trade leadership has faded away.

Now, as we all know, correlation does not necessarily mean causation, and it's frankly impossible to know just how much the dearth of US trade leadership has actually affected global trade policies.  But I think it's pretty safe to say that it certainly hasn't helped matters.  Just ask yourself this: how can the US admonish Brazil or any other country about its distressing mercantilism when the President is himself routinely preaching - and his administration is busy implementing - similar policies?  How can we decry the global "currency wars" when we're discretely advocating a similar strategy?  How can we push back against nations' increasing use of market-distorting subsidies or regulatory protectionism when we're....

I think you get the idea.

As I've frequently noted here, it was a Democrat - Secretary of State Cordell Hull - who over 70 years ago began a global free trade movement that until very recently had been led - in word and deed - by Republican and Democratic administrations alike.  And while the distressing recent spike in global protectionism may not have been caused by a lack of American trade leadership, it is very, very likely not going to recede until the United States regains its long-held place at the front of the trade liberalization pack.

[Final note: it looks like former USTR and current World Bank chief Robert Zoellick agrees.]

Behold, the Utterly Dismal State of American Trade Politics

One of this blog's most frequent refrains is the argument that free traders in the United States - particularly those in the political sphere - need to drastically change course in order to restore the pro-trade consensus here.  Cato's Dan Ikenson and I have written not one, but two papers on this subject since 2009, each arguing that (i) protectionist positions mostly revolve around a few very-trite-and-easily-debunked myths about imports, the trade deficit, foreign competition and the US manufacturing sector; and (ii) the case for free trade is far deeper and broader than the standard pro-trade mercantilism that you most often hear in Washington DC.

Despite ample evidence and polling data supporting our views, it has become abundantly clear in this election cycle that almost no one on Capitol Hill, in the White House, or out on the campaign trail is listening.  In a great new Bloomberg op-ed, NRO's Ramesh Ponnuru (who, by the way, years ago authored one of the great takedowns of Public Citizen and their protectionist benefactor Roger Milliken) explains that DC remains populated by alleged free traders using the same old mercantilist arguments, and that those arguments appear to be increasingly self-defeating (and delusional):

Economists, or at any rate the vast majority of them, say nations should lower their barriers to imports because it promotes the efficient allocation of resources. That argument doesn’t depend on whether other countries are making trade agreements with one another. It doesn’t even depend on whether those countries have barriers against our imports. The theory suggests that if nations lower their barriers to one another’s imports, they will make more gains than if only one country does so. It also suggests that a country makes itself better off by lowering its barriers unilaterally. 

U.S. politicians who support free trade rarely make any such argument, and haven’t done so for decades. Instead they make mercantilist arguments for free trade, in which we must regrettably open our markets to foreign imports as the price for getting other countries to do the same for our exports. In debates over trade agreements, both sides typically accept the notion that imports are bad and exports are good. The question becomes whether the agreement will do more to boost imports or exports.

It isn’t uncommon for administrations that seek to liberalize trade overall to erect barriers for the benefit of this or that industry. The Bush administration briefly imposed steel tariffs to placate members of Congress from the Rust Belt. The Obama administration has placed tariffs on tires (at a cost of at least $900,000 for each job saved). This tactic fits comfortably within the political consensus for free-trade mercantilism. 

In recent years, the debate has narrowed still further because both sides have converged rhetorically. Protectionists in the U.S. do not advertise themselves as such: They say they favor free trade so long as it is fair. Free traders don’t wish to be portrayed as supporting unfairness, and so everyone calls himself a supporter of “free and fair trade.” 

Whatever its theoretical inadequacy, free-trade mercantilism has worked pretty well since World War II. It has enabled a vast expansion of global trade and thus of global wealth. But it is yielding diminishing returns as a strategy for liberalizing trade. Public support for open trade has fallen in the U.S. Majorities in the 1990s thought “the opportunity for economic growth through increased U.S. exports” outweighed the “threat to the economy from foreign imports.” They no longer do.

Ponnuru then concludes that the current mercantilist approach to trade has proven to be a "political failure," and that "the failure of almost anyone in politics to make the real and unequivocal argument for [free trade] has almost certainly been one" of the reasons why public support for it is in the crapper.

If this solid argument sounds familiar to you, it should: it's almost exactly what Ikenson and I argued last year as we explained just how pro-trade mercantilism "sows the seeds of its own destruction":

Many of trade's most vocal and active proponents in government and the private sector have relied too heavily and for too long on a faulty marketing strategy, which posits that more trade and more trade agreements mean more export opportunities, and more exports mean more economic growth and more jobs. The political appeal of that message is obvious, and there is nothing dishonest about it. Exports do contribute to economic growth, which is essential to job creation.

However, that message invites the following retort: if exports help grow the economy and create jobs, then imports must shrink the economy and cost jobs. In failing to explain why that conclusion about imports is wrong, trade proponents have yielded the floor to trade skeptics, who have been more than happy to manufacture talking points about the "deleterious" impact of imports on the U.S. economy. Most of those talking points are misleading or plain wrong, but there has been inadequate effort to correct the record. As a result, too many Americans accept the mercantilist fallacy that exports are good, imports are bad, and the trade account is a scoreboard.

The pervasive view that exports are good and imports are bad is a central misconception upon which rests the belief that trade negotiations and "reciprocity" are essential to trade liberalization. Under this formulation, an optimal trade agreement, from the perspective of U.S. negotiators, is one that maximizes U.S. access to foreign markets and minimizes foreign access to U.S. markets. An agreement requiring large cuts to U.S. tariffs, which would thus deliver significant benefits to consumers, would not pass political muster unless it could be demonstrated that even larger export benefits were to be had. This misguided premise that imports are the cost of exports and should be minimized lies at the root of public skepticism about trade. Ironically, it is also a prominent feature of the favored pro-trade argument.

We conclude by explaining how a more robust pro-trade message - one which focuses on the economic benefits of exports and imports and, more importantly, the moral case for free trade and against protectionism - can improve highly-malleable public opinion and help free trade advocates win the trade debate once and for all.

As noted above, however, no one seems to be listening.  Indeed, things appear to be deteriorating, as the presumptive leader of the pro-trade Republican Party, Mitt Romney, not only has taken the mercantilist route when advocating FTAs, but also has vocally embraced protectionism - at least when it comes to China.  I've already lamented Romney's troubling turn on China, but recent reports indicate that he has really been ramping up the rhetoric over the last few weeks.  First, his top spokespeople are being anything but shrinking violets on the issue:

Mitt Romney’s calls for confronting China as a currency manipulator, intellectual property thief and trade cheat are what distinguishes his economic vision from Republican orthodoxy, his top policy adviser said.

Lanhee Chen, policy director for the presumptive Republican presidential nominee, said while Romney’s plan for “robust” action to confront China on trade issues may be at odds with some in his party and Democrats, it is at the core of his strategy for improving the economy.

“Here’s a place where Governor Romney is really calling for a different approach, for example, confronting China on their currency manipulation, on their intellectual property stealing, on the barriers they put up really to competition from foreign firms,” Chen said in an interview on Bloomberg Television’s “Political Capital With Al Hunt” airing this weekend.

“This is really a path forward that will be quite different from” policies under Presidents Barack Obama and George W. Bush, Chen said.

Romney, 65, “has been in touch” with former Secretary of State Henry Kissinger, a China specialist who disagrees with Romney’s aggressive stance, Chen said, adding: “But look, the bottom line is, Governor Romney is going to do what it takes to get our economy going, including confronting China, and there will be some in both parties that will disagree with him.”

Video of Chen's aggressive comments are here.  And, speaking of video, the Romney campaign has cranked out several anti-China TV ads too:

Two of Mitt Romney’s first three television ads of the general-election campaign boast of how he’d stand up to China as soon as he becomes president...

On the campaign trail, Romney labels China’s leaders as “cheaters” and “currency manipulators.” His ads say the Republican nominee would be a president who “stands up to China on trade and demands they play by the rules.” He has vowed to issue,on his first day in office, an executive order labeling China a currency manipulator.

So, it's abundantly clear that Team Mitt will be yelling about China all the way through November (regardless of what the facts say).  At the same time, however, the article above makes clear that most observers - myself included - don't think that Romney will actually keep his anti-China promises if he becomes the next POTUS.  Indeed, BusinessWeek notes that, according to an unnamed source within the campaign, "all of Romney’s top advisers disagreed with the candidate’s vow to take a harder line on China with new tariffs and an official designation as a 'currency manipulator.'”  Thus, it's pretty clear that Governor Romney's position on China is intended to be a cynical political maneuver rather than a hard promise to impose new taxes on US consumers and to start a trade war with one of America's largest trading partners.  In that way, Romney's China pledges are pretty similar to President Obama's ultimately-empty 2008 promises to re-negotiate NAFTA.

But while Romney's position probably won't lead to the implementation of new protectionist policies if he becomes President (undeniably good news), Obama's similar protectionist proclamations in 2008 show us that such rhetoric is far from harmless.  Indeed, as Ikenson and I noted last year, historical data from Pew's annual survey of US views on trade show that American attitudes toward trade are shaped largely by what Americans hear from the media and their elected (or campaigning) officials:

The dramatic decline in pro-trade sentiment between 2007 and 2008 coincided with a U.S. presidential primary election campaign season in which the Democratic candidates routinely criticized U.S. trade policy and certain trade partners. Perhaps most memorable was the late-February 2008 debate at Cleveland State University on the eve of the Ohio primary, when the late Tim Russert extracted renunciations of NAFTA and pledges from candidates Hillary Clinton and Barack Obama to reopen and renegotiate terms of the agreement...

The results of the 2009 Pew poll... suggest that political leaders can indeed influence public opinion about trade. The greatest fluctuation in public support for trade between 2007 and 2009 came from self-identified Democrats — those paying most attention to the Democratic primary elections and President Obama's early speeches — with opposition swinging wildly from 37 percent in 2007 up to 50 percent in 2008 and down to 30 percent in 2009. Meanwhile, support among Republicans remained steady during this period, as the issue was almost nonexistent during the GOP primaries and rarely discussed by Republican nominee John McCain during the general election campaign.

Assuming that Romney's China-bashing speeches and commercials have a similar effect on the electorate in 2012, it's quite likely that public support for free trade will wane this year and into next.  Indeed, the harmful effects of Romney's message on US trade sentiment could be even bigger than in 2007-08, given that the Democratic party (including President Obama) routinely engages in protectionist pandering during election season, and Romney's position as the leader of the Republican party will certainly diminish the GOP's traditional pro-trade counterweight.

Thus, while Romney's political advisers may view his China-bashing as a harmless way to help pave the road the White House in 2012, President Romney and his team may arrive there in 2013 facing an trade-hostile US electorate that makes any major free trade policies too politically unpalatable to be undertaken.

And they'd have only themselves to blame.

So, if/when this all happens, does anyone actually expect the Romney administration to advocate its new trade proposals using anything except the same old, self-defeating mercantilist arguments?  I try to be optimistic - really, I do! - but it sure ain't easy.

So we'll probably do this all over again in 2014 and 2016 and, well, until we find a politician brave - and smart! - enough to ditch the mercantilism and adopt a new approach to trade based on the realities of today's global economy and the abject falsity and immorality of the anti-trade position.  Trust me, these politicians do exist (I've worked with them), but it's increasingly - and depressingly - clear that they won't be in the White House anytime soon.

Delicious: DC's Top (Reputable) Currency Hawk Dramatically Lowers Estimate of RMB Undervaluation

Over the last few years, the debate in the United States over China's currency practices has taken significant RMB undervaluation as a given and focused more on its effects and possible US responses. A few folks out there (like your humble correspondent) have questioned this fundamental assumption, but for the most part - especially in Congress - the idea that the RMB might not be as super-undervalued as everyone says is rarely, if ever, entertained.  A primary reason for this strongly-held assumption is the fact that the highly-reputable and (mostly) pro-free trade Peterson Institute for International Economics has loudly and repeatedly told Congress - and pretty much anyone else who'll listen - that their rigorous economic models clearly and unequivocally demonstrate that, despite some appreciation over the last few years, the RMB remains seriously undervalued.  Congress, the Obama administration and campaigning politicians like Mitt Romney, in turn, have repeatedly cited to PIIE's numbers to justify their calls for more aggressive US action against China's currency practices. So what's going to happen on the Hill, in the White House and on the campaign trail now that PIIE's top currency hawk has dramatically changed his tune on the RMB?

A ballooning surplus as China’s exports soared provided the smoking gun in the case against China’s undervalued currency. Economists reasoned that it was the undervalued yuan that was responsible for China’s massive surplus, and a substantial appreciation would be required to correct it.

Helping lead the analytic charge was William Cline, a senior fellow at the Peterson Institute in Washington D.C.

In 2008, working with fellow Peterson economist John Williamson, he estimated the yuan would have to appreciate by 18% in real effective terms, 31.5% against the dollar, to bring China’s current account surplus down to 3% of gross domestic product.

Now, though, a surplus that expanded to 10.1% of GDP in 2007, has shrunk to just 2.8% in 2011 – already below the 3% target.

That has prompted economists to return to their spreadsheets to try and work out whether the contraction is a temporary blip, or here to stay, and what that means for the yuan.

The International Monetary Fund is expected to ratchet down its medium term estimate of China’s current account surplus when it publishes its World Economic Outlook next week, down from above 7%.

Mr. Cline is getting ahead of the curve. “I am coming to the conclusion that the current account surplus is likely to be lower than in past projections,” he said, sharing his latest thinking with China Real Time....

“If the medium-term surplus reaches 4% to 5% of GDP and the international norm is a ceiling of 3%, then it requires 1% to 2% of GDP reduction in the current account” he said. ”Given the size of exports in the Chinese economy, a 1% real effective appreciation of the exchange rate reduces the current account surplus by 0.3% of GDP. So a real effective appreciation of about 3.5% to 7% would be required to reach the target.”

That is a pronounced reduction in Mr. Cline’s estimate of the extent of yuan undervaluation.

"Pronounced" is a serious understatement: only a few months ago, Cline and his PIIE colleague estimated that the RMB was undervalued by a whopping 24%.  Now, he's down to about 5%.  That's quite the shift in only a few months, and the reduction blows a giant hole into the longstanding argument the United States must pursue aggressive, unilateral action to compensate for China's dangerous currency practices.  (Sorry, Fred!)

Now, I don't cite to Cline's revisions to make some definitive case that the RMB isn't undervalued or that China's currency policies are all fine-and-dandy.  No, my point remains the same as is has been for the last several years: it is simply impossible to know the extent and effect of China's currency policies, so American politicians and pundits are mind-blowingly wrong to push harmful US trade policies (like tariffs or other nasty things) and to incite public fear and anger on the basis of PIIE's (or anyone else's) wild guess as to what the RMB's worth and what it's doing to the US and global economies.

And just think if we had followed these politicians into the protectionist abyss on the basis of these uncertain numbers.  (We got really close: China currency bills passed the House in 2010 and the Senate in 2011.)  We'd be smack-dab in the middle of a nice little US-China trade war over either a problem that fixed itself in only a few short years or what turned out to be a steaming pile of hokum.

There's a lesson here, although I unfortunately doubt that its target audience will listen.

Indeed, now that Cline (and some of his PIIE colleagues) have changed their tune on the RMB, how many DC politicians are going to stop complaining about China's currency?  And how many US labor unions and protection-craving businesses will stop demanding consumer-crushing tariffs on Chinese goods to counteract China's supposed currency "manipulation"?  (Two days before Cline revised his figures, the US Steel Industry demanded that the House pass the Senate's currency bill.  I'm sure their retraction's coming any minute now.)

No, no one's going to change his tune in this election season.  Instead, the charade will continue, as it has for the last several years.

But that doesn't mean we have to listen to them.

The Potential Downside of Chinese "Re-balancing": US Inflation

With China recording an unexpectedly huge trade deficit in February 2012, the punditocracy has rushed to opine on the potential effects of Chinese "re-balancing" - i.e., a shift away from economic growth driven by exports and foreign investment (due mainly to relatively cheap labor and currency) to growth driven more by domestic consumption.  Most of the commentary has looked at a "re-balanced" China's potential problems for Chinese exporters and potential gains for US exporters, but I'd like to look at another possible effect of Chinese re-balancing: the loss of two significant, longstanding brakes on harmful inflation in the United States.

Before I get to that, let's dig into China's surprising trade data, courtesy of the WSJ:

A trade deficit of $31.5 billion in February is the largest on record for the world's second-largest economy....

With the lunar holiday for Chinese New Year playing havoc with the data, it makes sense to look at January and February's trade numbers together. On this basis the trade deficit is a less-alarming $4.1 billion-because of a substantial surplus in January-but remains the largest for the first two months of the year since 2004.

Exports grew just 6.8% compared with the first two months of 2011, down from 14.2% growth in the final quarter of 2011. No prizes for guessing the main reason for the fall: exports to Europe contracted 1.1%....

Qu Hongbin, Asia economist for HSBC, notes that growth in processing trade imports fell to 2.4% compared with a year earlier, down from 8.6% in the fourth quarter of 2011. Those imports are the inputs to make China's own exports. Such a low growth rate suggests factories are anticipating weak demand for their products down the line, and going slow on accumulating stock.

Another WSJ article gives us the money graphic:

The article added that "[l]ooking at January and February together, exports rose 6.9%, while imports gained 7.7%, far slower than the double-digit gains China usually chalks up."

So what's causing the sudden shift in China's trade balance?  Well, some of the change is clearly due to falling demand abroad, particularly in crisis-torn Europe (as the WSJ notes), but a broader look at China's exports (courtesy of Michael McDonough) indicates that there may be something bigger and more systemic going on here:

The chart above makes clear that Chinese exports have steadily declined over the last 2 years across the globe, not just in Europe.  I have no idea if this means that China actually has begun to "re-balance," but if China's growth model really is moving towards domestic consumption and away from export-dependence, domestic factors like rising living standards and a stronger currency are likely at play.  If so, that's good news for Chinese consumers and certain US manufacturers that compete directly with China and other low-cost Asian manufacturers.  Unfortunately, there's a downside to these re-balancing factors: they should make it increasingly difficult for the United States to keep inflation at bay.

First, rising labor and other costs in China have made Chinese exports more expensive. This well-documented trend will affect not only China's trade balance, but also US inflation:

Since the 1990s, Chinese imports have helped cool inflation in the U.S. That allowed the Federal Reserve to keep interest rates a bit lower, allowing the economy to grow at a quicker pace.

But with wages rising, the cost of China-made goods has begun to go up. That is bound to continue, and as it does the U.S. economy will look a little more inflation-prone. The Fed's job is going to get more complicated.

The U.S. imported $399 billion in Chinese goods last year, according to the Commerce Department. That was quadruple the $100 billion imported in 2000, the year prior to China joining the World Trade Organization, and ten times the $39 billion imported in 1994.

The jump in Chinese imports has coincided with a period in which inflation has been remarkably quiescent. Over the past 15 years, the core consumer-price index, which excludes food and energy, has risen at an average annual rate of 2.1%, according to the Labor Department, compared with 4% in the 15 years previous.

Much of that downshift owes to a cooling in prices for goods—that is, prices for stuff like t-shirts, which can easily be imported, rather than services like haircuts, which can't. Core consumer-goods prices have increased at an average annual rate of 0.2% over the past 15 years, compared with 2.9% in the 15 years before that.

The Chinese import prices have lately been increasing, however, rising 3.9% last month from a year earlier, according to the Labor Department. Some of that owes to higher commodity costs, but rising Chinese wages and an appreciating yuan also seem to be playing a role. One indication of that: Prices for footwear imports—labor-intensive goods that use a minimal amount of raw material and are mainly made in China—have risen 5.5% over the past year.

While a cooling Chinese economy could offer some temporary respite, China has reached a point in its development where it will be difficult to keep labor costs in check. Some manufacturers are shifting operations to other low-wage Asian countries, but the scope for doing that is limited—there are only 90 million people living in Vietnam compared with China's 1.3 billion.

This isn't to say that rising prices in China will be pushing prices higher in the U.S. Rather, they won't be pulling them down. So the U.S. economy will look a little more inflationary, and a little less productive—a little more like it looked before China entered the scene.

A brand new report from the WSJ indicates that rising Chinese labor costs are having a "ripple effect" on labor costs in other developing Asian economies like Malaysia, Thailand, Indonesia and Vietnam. Thus, the prices of these countries' exports are also on the rise:

More Asian governments are pressing businesses to hike wages as a way to prevent outbreaks of labor unrest, raising the specter of higher manufacturing costs for global companies—and the products they sell world-wide....

Global companies already have been facing higher labor prices in China over the past year, despite a weak global economy, as workers demand a greater share of the country's economic boom. In recent months, the pressure also has intensified in countries across Southeast Asia that have marketed themselves as alternatives for companies seeking to escape China's rising costs, leaving those companies now with fewer places to move....

Asian governments, in some cases, are embracing the call for higher salaries, in part to head off the spread of the kind of unrest that has toppled Middle Eastern regimes recently—and to calm rising labor actions in their countries.

They also are hoping the higher wages will help consumers boost spending, providing a new engine of growth at a time when slack demand for exports in the West and higher oil prices are worrying policy makers across the region.....

The spread of higher wages is likely to present challenges for the companies that have long relied on Asian manufacturing operations to keep their costs low, potentially including multinationals, such as Nike Inc., Adidas AG, Dell Inc. or their suppliers....

Boosting minimum wages risks setting off more inflation at a time when central bankers are worried about increased oil prices. Such a scenario could put the price of ordinary goods out of reach of the people the higher wages are intended to help.

Garment, footwear and electronics manufacturers operating in Indonesia from South Korea, Taiwan and Japan say they are now thinking of taking their factories elsewhere. Some said they fear more wage increases as local politicians try to win votes in elections scheduled over the next two years....

But with wages now rising in so many places at once, unhappy companies may have few places to escape.

If rising Chinese import prices are removing a brake on US inflation, then rising prices of other Asian imports   should have a similar and supplemental effect.

Second, in real terms, the Yuan has appreciated significantly against the US dollar over the last several years.  This appreciation will undoubtedly decrease some Chinese exports and increase domestic import consumption, but it might also have a significant effect on US inflation because of how China manages the value of the Yuan.  As I've repeatedly noted, much of the Yuan's relative appreciation is due to significant Chinese inflation (caused by, among other things, economic growth, rising labor costs and Chinese monetary policy), but some of it is due to a noticeable shift in China's monetary policy, in particular its "managed peg" of the Yuan against the US dollar.  Until last week's trade surprising trade deficit, this change allowed (or forced) the Yuan to appreciate against the Dollar in nominal terms over the last year or so (chart again courtesy of Mr. McDonough):

So why did the Yuan's nominal value appreciate so much last year?  Well, one possible reason is that China stopped buying US government debt.  China helps control the nominal value of the Yuan by purchasing that debt, but the government's purchases slowed dramatically last year:

China's holdings of U.S. Treasuries accounted for 54% of its foreign-exchange reserves as of June 30, according to a U.S. Treasury survey released this week. That's down from 65% in 2010 and a record 74% in 2006....

Beijing continues to buy loads of U.S. debt. As of June 30 it held $1.73 trillion in U.S. securities, up 7% from June 30, 2010.

Still, other federal data show it was a net seller of U.S. treasuries in the second half of 2011.

Bank of America predicts that China will continue to diversify its debt holdings away from US Treasuries in 2012, even though most people expect the Yuan's nominal appreciation to slow this year.  Because global turmoil has made the United States the "debt of last resort," most experts note that China's diversification shouldn't have a huge affect on interest rates (and thus inflation) in the United States right now.  However, China's reduced foreign purchases of US Treasury Bills could eventually bite, as this new report from the Federal Reserve makes clear:

Foreign offi cial holdings of U.S. Treasuries increased from $400 billion in January 1994 to about $3 trillion in June 2010. Most of this growth is accounted for by a handful of emerging market economies that have been running large current account surpluses. These countries are channeling their savings through the offi cial sector, which is then acquiring foreign exchange reserves. Any shift in policy to reduce their current account surpluses or dampen the rate of reserves accumulation would likely slow the pace of foreign offi cial purchases of U.S. Treasuries. Would such a slowing of foreign o cial purchases of Treasury notes and bonds a ect long-term Treasury yields? Most likely yes, and the eff ects appear to be large.

The aforementioned Bank of America report echoes these concerns.  So, in short, should the Chinese government stop buying US debt in order to allow (or force) the Yuan to appreciate, an unfortunate - but totally expected - byproduct could be higher interest rates and increased inflation in the United States.

There are growing concerns from several reputable, non-partisan sources that inflation could become a real problem in the United States over the next year or so.  (Sky-high energy costs and ridiculously easy money can do that to a country.)  At the same time, President Obama and his administration are relentlessly pushing China to re-balance its export-dependent economy.  As noted above, part of that re-balancing process will undoubtedly involve more expensive Chinese (and other Asian) imports into the United States and also could involve fewer Chinese government purchases of US debt.  But given the potential adverse effects of such events on the inflation-prone US economy, advocates of Chinese re-balancing in the administration and elsewhere may want to recall an old bit of wisdom:

Be careful what you wish for.

Umm, Yeah, About China's Dangerous Trade Imbalance

Right on the heels of the US visit of Xi Jinping, Chinese Vice President (and likely to replace President Hu Jintao as secretary-general of the Chinese Communist Party), comes news that one of the main indicators of supposed Chinese trade malfeasance - it's global trade surplus - has all but disappeared:

China's current-account surplus for 2011 shrank to $201.1 billion, from $305.4 billion in 2010. More important, as a ratio of gross domestic product, the current-account surplus fell to about 2.7%. That's close to a decade low and below the 4% threshold that suggests an exchange rate out of whack with equilibrium.

The argument in past years has been that the fall in China's surplus is cyclical, the result of the investment-heavy domestic stimulus that led to a surge in commodity imports, and recession in major trade partners that crimped exports.

But the International Monetary Fund seems to think there could be something more at work. The IMF now predicts China's current-account surplus will be 3.8% of GDP in 2013, way down from a forecast of 6.2% last September. Taken together with an unusual fall in the value of China's foreign-exchange reserves in the final quarter of 2011, it's a serious challenge to the argument that the yuan is undervalued....

In an election year, and with unemployment at 8.3%, the U.S. might still ratchet up the rhetoric on the yuan. But investors should prepare for China to start ratcheting down the pace of appreciation.

The IMF is already re-examining whether China's currency remains "substantially undervalued" because (i) "the yuan has appreciated more than 8% in the last year and the fund is developing a new method of assessing global currencies; and (ii) "the real effective exchange rate, based against a basket of currencies and accounting for inflation, is up almost 20% in the last three months on an annual basis and by over 8% in 2011."  I've already noted that the significant increase in the RMB's real effective exchange rate (and decrease in the same metric for the USD), and recently the nominal RMB-USD exchange rate went below 6.3 for the first time since the early 1990s.  Couple these facts with China's disappearing trade surplus, and the IMF's re-evaluation certainly appears warranted.

Meanwhile, the US trade deficit just reached a six-month high.  Hmmm....

Now, I'm certainly not saying that China's trade balance is some sort of magical indicator of the success, failure or legality of Chinese trade policy.  As I've repeatedly explained, trade balances - particularly bilateral ones - are increasingly unimportant in this regard.  However, a lot of "important" people - like a certain New York Times columnist and various campaigning politicians - have relied on China's trade surplus to justify their breathless calls for aggressive US protectionism to counter China's supposedly-pernicious trade practices.  Indeed, in many cases, China's trade balance is the only reason cited for their extremely provocative anti-trade proposals. 

So with this supposedly-critical metric, along with various indicators of the value of China's currency, now arguing against such unilateralism, will these pundits and politicians revise their positions?

Don't hold your breath.

Everything You Need to Know About Obama's Trade "Enforcement" Budget (and the Political Problems with Romney's China Trade Plan)

President Obama officially released his 2012 budget today, and, as expected, it proposes significant new funds for the super-duper trade enforcement team - the "Interagency Trade Enforcement Center" - that he outlined during his recent State of the Union Address.  Because the substance and future of both the President's budget and the ITEC is in serious doubt (as I've already noted), it's probably a waste of time to spend too much virtual ink on the proposals and their implications.  But just in case you're just dying for commentary, here's all you really need to know about the whether the proposed agency is a good or bad thing for US trade policy (and what "enforcement" really means): the President's plan is strongly supported by the vehemently anti-trade United Steelworkers Union (USW).  In fact, USW President Leo Gerard issued a lengthy press release lauding the plan:

President Obama has acted to enforce America's laws against unfair trade since coming to office and announced in his State of the Union address last month, a clear commitment to this effort. The USW is especially pleased to know the President's budget will be asking for millions of dollars to arm his new Interagency Trade Enforcement Center (ITEC) with the resources needed to fight for American jobs.

Too many American workers have had their jobs stolen from them by foreign unfair, predatory and illegal trade practices. Many of our trade competitors agree to the rules, but then fail to abide by them. Enforcing our laws – and the commitments other countries have made – must be high priority. President Obama is devoting resources to accomplish that goal....

In his State of the Union message, the President highlighted the success of the trade case brought by the Steelworkers against a flood of tire imports from China that had been decimating employment here. His leadership has helped to return the industry to stability, put American tire builders back to work and has stimulated the expansion of production and investment here at home. His efforts deserve, and have, our sincere gratitude.

Yes, yes, the President's Chinese tire and other trade remedies efforts just might deserve, and have, the union's sincere gratitude, but, as I've repeatedly noted here, they - or, more accurately, the skyrocketing prices, injured retailers and consumers, rampant trade diversion and economic uncertainty that they created - certainly deserve everyone else's extreme ridicule and disdain.  And if the USW's anti-trade policy and the Chinese tire tariffs are an indication of what President Obama's new budget is going to buy us (on credit!), then we once again can be thankful that the plan won't be carried out.

Beyond helping us understand the true intent of President Obama's "enforcement" plans, the USW press release also provides further proof that placating anti-traders with token acts or promises of protectionism is a fool's errand, especially for Republican politicians.  After Gerard finished praising the President for his commitment to painful protectionism enforcement, he then lays into GOP hopeful Mitt Romney, alleging that  "[t]his President's budget makes an important investment in trade law. The Republican candidate, Mitt Romney, would jeopardize our successes and reverse course on enforcing the rules."  Gerard then spends a couple paragraphs hitting Romney - who, by the way, is campaigning in Michigan right now - for his views on the China tires case and the auto bailouts.

Yet never once does Gerard - who literally just finished praising President Obama's aggressive China protectionism - heap similar praise onto Romney for his even more aggressive stance on China trade and currency (a stance that even Obama won't take).  Now, I certainly think that Romney's China currency stance is misguided from a legal, moral and economic perspective, but some pro-Romney cynics have argued that, those fair criticisms aside, his policy is smart politics because it will attract votes and support in heavily-unionized swing states like Ohio, Pennsylvania and, yes, Michigan.  I disagreed with such political calculations (and continue to do so), and Gerard's statements provide support for my view that Romney's China trade plans are not only bad policy, but also bad politics.

Protectionists will just never - ever - be placated with token protectionism (especially when it's a Republican politician doing the placating).

Now, leaving the USW and other professional protectionists aside, Romney's China currency plan is already revealing another big political flaw: the policy's economic and legal failings undermine much-deserved criticism of Obama's very bad record on trade policy (another problem I noted a few months back).   Indeed, just a few days ago, NYU law professor Robert Howse dismissed a very good op-ed by Columbia's Jagdish Bhagwati that absolutely destroyed Obama's latest trade pandering.  Howse did so not by addressing the substance of Bhagwati's claims, but instead by simply pointing to Romney's even worse stance on China trade.  I'm quite sure that if Romney's the nominee, we can expect similar diversions from Obama supporters between now and November.  And considering just how bad President Obama's trade policy has been over the last few years, it's a real shame that the likely Republican standard-bearer won't be able to mount an effective, full-throated criticism.

Sounds depressingly familiar, now that I think of it.  Sigh.