Administration's Big "China Friday" Was Probably the Best We Can Realistically Hope For, but It's Still Not Great

Last Friday, the Obama administration had a rather busy day handling China trade issues.  First, USTR announced that it was initiating, at the United Steelworker's request under "Section 301" of US trade law, an investigation of Chinese subsidies and other trade measures related to "green" energy production:

U.S. Trade Representative Ron Kirk announced today that the United States has initiated an investigation under Section 301 of the 1974 Trade Act with respect to acts, policies and practices of the Government of China affecting trade and investment in green technologies. The investigation has been initiated in response to a petition filed by the United Steelworkers (USW) on September 9, 2010.

The petition alleges that China employs a wide range of World Trade Organization (WTO)-inconsistent policies that protect and unfairly support its domestic producers of wind and solar energy products, advanced batteries and energy-efficient vehicles, among other products, as China seeks to become the dominant global supplier of these products. According to the petition, these policies include export restraints, prohibited subsidies, discrimination against foreign companies and imported goods, technology transfer requirements, and domestic subsidies causing serious prejudice to U.S. interests. The petition further alleges that China’s policies have caused the annual U.S. trade deficit in green-technology goods with China to increase substantially since China joined the WTO, making China the top contributor to the U.S. global trade deficit in the sector....

The investigation will consider whether acts, policies, and practices of the Chinese government deny U.S. rights or benefits under the GATT 1994, under the Subsidies and Countervailing Measures Agreement (SCM Agreement), and under China’s Protocol of Accession to the WTO.

Under the Section 301 statute, the U.S. Trade Representative may request consultations with the foreign country concerned at the time an investigation is initiated. The statute also provides, however, that the U.S. Trade Representative, after consulting with the petitioner, may delay for up to 90 days any request for consultations for the purpose of verifying or improving the petition.

In light of the number and diversity of the acts, policies, and practices covered by the petition, and after consulting with the petitioner, the U.S. Trade Representative has decided to delay for up to 90 days the request for consultations with the Government of China for the purpose of verifying and improving the petition. During this period, the U.S. Trade Representative will seek information and advice from the petitioner and advisory committees. The U.S. Trade Representative will take account of this information and advice, as well as public comments submitted in response to a Federal Register notice, in improving and verifying the petition.

Because the issues covered in the China-Green Technology investigation involve U.S. rights under the WTO Agreement, any consultation request will be made under the WTO Understanding on Rules and Procedures Governing the Settlement of Disputes (DSU), and unless consultations result in a mutually acceptable resolution, the U.S. Trade Representative will request the establishment of a WTO panel under the DSU.

Only a few hours later, the Treasury Department announced (as predicted!) that it was delaying its Semi-Annual Report to Congress on International Economic and Exchange Rate Policies, in which it can deem countries to be "currency manipulators" under Sections 3004 and 3005 of the Omnibus Trade and Competitiveness Act of 1988:

Since June 19, 2010, when China announced it would renew the reform of its exchange rate and allow the exchange rate to move higher in response to market forces, the Chinese currency has appreciated by roughly 3 percent against the U.S. dollar. Since September 2, 2010, the pace of appreciation has accelerated to a rate of more than 1 percent per month. If sustained over time, this would help correct what the IMF has concluded is a significantly undervalued currency.

By continuing to implement reforms to strengthen domestic demand and by allowing the exchange rate to move higher to reflect fundamental economic forces, China will make a significant positive contribution to the global rebalancing effort, help reduce pressure on those emerging market economies that have more flexible exchange rates, and provide a more level playing field for trading partners around the world.

The challenge of building a stronger, more balanced and sustainable global economic recovery is a multilateral challenge, not just the responsibility of China and the United States. It requires policy reforms in all major economies.

The Heads of State, finance ministers, and central bank governors of the G-20 and the Asia-Pacific region will participate in several important meetings over the coming weeks. These meetings provide an opportunity to make additional progress on the important challenge of securing stronger and more balanced growth.

The Treasury will delay the publication of the report on international economic and exchange rate policies in order to take advantage of the opportunity provided by these important meetings.

No one in the White House would confirm that these two major China-trade announcements were related, but, c'mon, let's get real: the White House has been in quite the pickle on China trade and currency, and this is its grand Solomonic compromise.  On the one hand, they had labor unions and congressional Democrats rabidly campaigning against China trade - especially Chinese currency policies - in advance of what's shaping up to be a mid-term election bloodbath.  On the other hand, they understand fully that (a) aggressive unilateral action against China would probably violate WTO rules and could provoke serious Chinese retaliation against  US exporters; (b) calling China a "currency manipulator" less than a month before the G-20 summit would almost certainly salt the next multilateral opportunity to address global currency reform (the White House's preferred course of action); and (c) a very good argument can be made that China doesn't actually meet the legal standard for a "currency manipulator" under US law.  And compounding this stress were statutorily-mandated deadlines for the Section 301 investigation and the currency report that fell only weeks before the mid-term elections.  Thus, as I said in a few media interviews on Friday: "Given that United States Trade Representative’s Section 301 decision wasn’t due until October 24, it is either tied to Treasury’s currency announcement or one extremely large and convenient coincidence."

And in all honesty, I must admit that, given this administration's routine prioritization of trade politics over trade policy, Friday's tandem announcements are about the best that we could've hoped for.  Let's face it: considering the aforementioned political dynamics and the fact that the Commerce Department recently rejected two petitions to investigate Chinese currency practices under the US countervailing duty (anti-subsidy) law, there was absolutely no chance - NONE - that the White House was going to issue the semi-annual Treasury report and not label China a "currency manipulator" a little more than two weeks before the mid-terms.  And by delaying the report, Treasury has allowed the G-20 negotiations to remain viable.  As I said on Friday: "The Treasury report’s delay is a good sign for those discussions. A bunch of name calling right before you get together for an adult conversation is not the best strategy to use when conducting international negotiations that could affect hundreds of billions of dollars in global trade." Harumpf!

Second, initiating the Section 301 investigation is relatively harmless.  As the USTR announcement makes clear, the agency will now hold 90 days worth of meetings with the USW and other interested parties in order to "improve and verify" the union's petition.  Then USTR will simply initiate bilateral consultations with China through the WTO - the preferred multilateral channel for global trade dispute resolution.  As I said when the USW petition first dropped: "Section 301 is not like Section 421 (the tires case) or antidumping and countervailing duty investigations (the other cases mentioned), which can result in the unilateral imposition of remedial US tariffs on Chinese products. Instead, the very best outcome here is (i) the mutual resolution of the matter through bilateral consultations or (ii) a WTO case adjudicated by an independent panel of arbiters (unlike the, ahem, sympathetic US Department of Commerce or USTR)."  And, really, the USW's petition probably has some merit.  Indeed, with hundreds of billions in Chinese government subsidies to its "green" manufacturers over the years, how couldn't it?

Third, even if the USW's case some day results in WTO-sanctioned retaliatory tariffs on Chinese "green" products (solar panels, wind turbines, etc.), at least it would be on only one class of products, whereas a broadbased assault on China's currency could literally end up affecting Chinese imports of everything.  (And China's retaliation would, of course, reflect that big difference.)

Finally, the administration's compromise was pretty successful politically.  As this McClatchy article demonstrates, the dual announcements caused congressional protectionists like US Sen. Sherrod Brown (D-OH) to focus on the "good" Section 301 news and mute their criticism of the "bad" news on the currency report.  (For example: "Top Democrats publicly ignored the Treasury decision, focusing instead on the administration's decision to accept a United Steelworkers complaint that China is unfairly subsidizing its "green technology" sector. The office of the U.S. trade representative will investigate the complaint.")

So all-in-all, the administration's move was a pretty agile political tap-dance that minimized anti-trade backlash.  Not too shabby, really, and probably the best we free traders could expect.

That said, Friday's Section 301 announcement wasn't completely free from problems.  First, it's not exactly clear how USTR will navigate the difficulties that the Section 301 law itself raises under WTO rules.  The EU challenged Section 301 at the WTO and, while the adjudicating panel found that USTR could apply the law consistently with WTO disciplines on the resolution of trade disputes, it also stated very plainly that its ruling was dependent on USTR sticking closely to those disciplines.  In particular, the panel found that the timelines established under US law for the imposition of unilateral trade measures under Section 301 could conflict with WTO timeframes for the resolution of a panel dispute, but USTR had discretion to ensure that those WTO timeframes weren't violated.  But can you imagine the ruckus that Sherrod Brown and his congressional cronies - many of whom routinely complain about the WTO - would cause if the "official" Section 301 deadline arrives, and a WTO Panel still hasn't ruled?  That should make for some, umm, interesting tension between Congress and USTR, don't you think?

Second, even though USTR's announcement is pretty benign, Chinese retaliation still might be on the way.  Indeed, preliminary news reports from today indicate that China may (and I stress the word "may") have restricted exports of "rare earth minerals" - necessary for all sorts of high tech manufacturing - to the United States as part of its angry response to USTR's decision.  (The "rare earths" dispute has been brewing for a while, so I'm not convinced that today's news is really related to the Section 301 decision.)

Third, the new 301 dispute could open a whole can of worms regarding international trade conflicts over "green" policies and protectionism.  A big, contentious US-China dispute on "green subsidies" raises much, much larger retaliation concerns than those raised by China's actions today.  As I noted last month, the USW's petition freely admits that the United States has doled out at least a $100 billion of its own cash on US green manufacturers, and I've been nervously reporting for over a year now on the growing number of trade disputes surrounding green subsidies and other forms of protectionism.  If USTR's case goes forward, and then China files its own case against US subsidies, that could affect hundreds of billions of dollars in global trade.  And other cases by other WTO Members could easily follow (global trade disputes are very prone to copycat cases) - further accelerating the tit-for-tat trade tensions surrounding trade in environmental goods.

In sum, while the White House's big "China Friday" was about as good as can be expected from this administration, it wasn't great.  So strap in, folks, we've still got a long way to go on this one.

On That "Predatory" Chinese Currency Manipulation

Tomorrow, the Treasury Department is supposed to release its Semi-Annual Report to Congress on International Economic and Exchange Rate Policies, in which it can deem countries to be "currency manipulators" under Sections 3004 and 3005 of the Omnibus Trade and Competitiveness Act of 1988.   I'm guessing that the Department will once again delay the report's release in order to maintain pressure on China in advance of next month's G-20 summit in Seoul, but a lot of folks want Treasury to name China a "manipulator" in the report and to do so immediately.  In order to do that, the law mandates that Treasury must determine that the Chinese are "manipulat[ing] the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade."

Critics of Chinese policy certainly think such "unfair" behavior is going on, and they routinely accuse China of harboring "predatory" intentions when it pegs its currency to the US Dollar (or, more precisely, allows the RMB to float in a very narrow band).  For example, here's future-former-Senator Arlen Specter* (RD-PA) on the subject back in April:

Free trade MUST mean compliance with international trade law, or America has the right to say no and confront a system that is destroying the jobs and livelihood of thousands of workers.

The chief threat is from China, whose predatory trading practices and currency manipulation are flooding the market with low-priced imports in violation of international trade laws.

Clearly, Sen. Specter and many of his cohorts believe (or at least say they believe) that China refuses to let its currency float because of some pernicious desire to destroy the American manufacturing sector and, as they hilariously say in South Park, to take 'r jobs.  But is that really the case?  Is China's currency policy really some dastardly weapon that the Communist Party of China is deploying to annihilate the capitalist menace that is the dear ol' U.S. of A?

A new, must-read article in Foreign Policy by Ethan Devine makes it pretty darn clear that (i) Specter and other China-mongers have no idea what they're talking about when they throw around such accusations, and (ii) any decision by the Treasury Department to label China a "currency manipulator" as defined by US law is far more a product of politics than of reality.  And more broadly, Devine ably demonstrates that China's frightening and inevitable ascension to the top of the global economy is, well, far less frightening and inevitable than America's sinophobes and sinophiles (yes, I'm looking at you, Tom Friedman) would have us believe.

In short, Devine shows that China's rise as an economic power closely tracks that of another Asian nation with an "inevitable" economic ascent and a "clear intent" to crush the United States through its currency policies, export-driven economic growth and rampant industrial planning: Japan (stop me if you've heard this one before).  He also shows how all that great central planning and currency pegging ended up causing Japan's economy to come crashing down, and how the same thing could happen in China unless it figures out a way to transition its economy from one dependent on manufacturing and exports to one more reliant on domestic consumption and services.  That transition, however, is a lot easier than it sounds because China's state-run economy is not well-equipped to handle such a move.  And if China can't pull off the rebalancing move, it's in deep, deep trouble.

Devine's article is quite long and definitely worth a full read, but here are a few of my favorite excerpts:

The funny thing is that China borrowed much of its economic model from Japan: producing low-cost exports to fund investment at home while aggravating trading partners. At times, it seems like only the names have changed. Where Detroit automakers once denounced Honda and Toyota for dumping cheap, fuel-efficient sedans on American housewives, Treasury secretaries now wring their hands about the undervalued renminbi while China's trade surpluses yawn.

As pleasurable as it must be for China's leaders to have beaten Japan at its own game, the joke might soon be on them. In fact, they would do well to veer off of Japan's development path promptly. Sure, Japan's export boom funded stellar growth for four decades. But its undervalued currency eventually helped blow one of the largest bubbles in history, the bursting of which still hobbles Japan today. Japan's famously dismal demographics didn't help, but China's aren't much better. Beijing's one-child policy, introduced in 1979, has worked its way up the population pyramid such that China's supply of rural workers ages 20 to 29 will halve by 2030. Worse yet, China is much larger than Japan -- which means that the global consequences of a crash would be far greater.

...

One argument is that the United States forced Japan to act against its own interests in accepting a stronger yen. Although it is true that the United States and other trading partners browbeat Japan, they had been doing so for years. Japan finally assented to their demands in 1985 as part of a plan to rebalance its economy. Post-World War II Japan pioneered Asia's export-driven growth model, sextupling GDP from 1950 to 1970 and pulling more people out of poverty more quickly than any country except modern China. Japan achieved this remarkable growth with a weak yen -- which supported exports and discouraged imports -- and high savings rates, which funded massive investments in infrastructure and manufacturing capacity.

An unfortunate side effect of export- and investment-driven growth is that it strangles the consumer. But that's kind of the point: The entire exercise depends on suppressing consumers as their cheap labor fuels exports. In Japan's case, the same undervalued yen that supported exports sapped consumers' purchasing power while yields on their savings were kept artificially low to fund cheap loans to corporations and government. And the shrunken share of economic spoils that did end up in the hands of consumers had no outlet but the heavily protected domestic market with its hopelessly inefficient and shockingly overpriced goods and services. When American humorist Dave Barry traveled to Japan in 1991, he was stunned to find department stores selling $75 melons.

The result was a horribly lopsided economy. Consumption generally accounts for around 65 percent of GDP in most modern market economies, while investment in fixed assets such as infrastructure and manufacturing capacity makes up 15 percent. In 1970, Japan's figures were 48 percent and 40 percent, respectively. In plain English, the Japanese were consuming relatively little while investing heavily in steel plants and skyscrapers, which didn't leave much for fish or tourism. Belatedly, Tokyo realized that a balanced economy must also have consumption and that coating the country with factories and infrastructure wouldn't do the trick. Japan tried to rebalance slowly through the 1970s and early 1980s: The yen was allowed to strengthen a bit each year, and consumption ticked up to 54 percent of GDP, while investment shrank to 28 percent by 1985.

Having accomplished this much, Japan's leaders thought in 1985 that it was finally safe to strengthen the yen. As one high-ranking Japanese central banker explained privately several years later, "We intended first to boost both the stock and property markets. Supported by this safety net -- rising markets -- export-oriented industries were supposed to reshape themselves so they could adapt to a domestically led economy. This wealth effect would in turn touch off personal consumption." With the benefit of hindsight, we know this was a bad idea. The strong yen touched of a wicked asset bubble that quite literally blew Japan's economy to pieces, and many in China think this was the United States' aim. Xu Qiyuan, a researcher at the Chinese Academy of Social Sciences, summarizes the popular Chinese view. "It is a conspiracy theory.… A lot of Chinese people think that the United States forced Japan to appreciate in order to make the economy collapse and that it is trying to do the same thing to China," he told Reuters.

In fact, Japan's stronger currency would not have led to economic collapse if the domestic economy had been able to take the baton from exports. In the event, export-oriented industries did not adapt to a domestically led economy because the domestic economy was not fit to lead. Conceived as a tranquil oasis for the Japanese to enjoy their exporters' hard-fought gains in peace, domestic Japan frowned on competition. Former Japanese Vice Finance Minister Eisuke Sakakibara termed this the "dual economy," in which world-class exporters existed alongside domestic companies that were "very tightly regulated with a lot of subsidies from the government, which makes them extremely uncompetitive." As a result, productivity in Japan's service sector lagged manufacturing badly. Having nowhere better to go, the Bank of Japan's loose money found its way into stocks and real estate instead of funding innovation.

...

China is far more dependent on exports and investment than Japan ever was, and the numbers are still moving in the wrong direction. Investment accounts for half of China's economy while consumption is only 36 percent of GDP -- the lowest in the world, drastically lower than even other emerging economies such as India and Brazil. But as the Japan example illustrates, low consumption leads to high savings, and China's thrifty citizens, coupled with booming net exports, have bestowed upon the country the world's largest current account surplus, triple that of Japan's in 1985.

Much has been made of China's trade surpluses, and it is easy to get lost in the numbers. At times like these it is important to remember just how large China is -- and that in terms of global economic impact, it is only getting started. With GDP per capita only one-tenth that of the United States, China is already the second-largest economy in the world. Chinese infrastructure spending moves global commodity markets, and many basic materials set record prices over the last few years thanks to China's nation-building efforts. With steel capacity per capita only half of Japan's 1974 peak, China can already produce more steel than the United States, Europe, Japan, and Russia combined. In addition to its investment boom, persistent Chinese net exports and current account surpluses also generate significant global financial imbalances. In 1988, Japan's foreign exchange reserves stood at 5 percent of Japanese GDP and 0.7 percent of global GDP, whereas China's are now half of Chinese GDP and a full 5 percent of global GDP. Reserves of this magnitude have the potential to destabilize the Chinese and global economies.

Bulging foreign exchange reserves don't only irritate trading partners; they also stoke inflation pressures at home. Inflation is dangerous in a still-poor country where much of the population cannot tolerate higher prices for basic essentials, but it is a natural consequence of an undervalued currency. When Chinese exporters give their dollars to the Chinese central bank (PBOC), the renminbi they receive in exchange increase the domestic money supply and cause inflation. Official inflation statistics are rising, but they only tell part of the story. Massive liquidity in the system has caused a number of mini-bubbles such as garlic's hundredfold price increase over the last two years.

Giving exporters four renminbi per dollar instead of six would be the quickest fix, but China prefers "sterilization" instead of currency appreciation. In sterilization, the central bank issues bonds to soak up the extra renminbi. The catch is that China's dollar reserves earn dollar interest rates, so if the PBOC pays a higher rate on its own bonds, it pays out more interest than it earns. To keep from hemorrhaging money, the PBOC must keep China's interest rates close to U.S. rates. But U.S. rates are far too low for China, particularly with food prices rising and assets looking bubbly. The government has tried targeted policies such as price controls on certain foodstuffs and restricted lending to asset speculators, but the inflationary pressures are so great that this piecemeal policy resembles a game of whack-a-mole.

...

Although there is no doubt that this new growth strategy created tens of millions of jobs and a glistening national infrastructure, the attendant imbalances have created problems. Huang notes that by suppressing personal consumption and small-scale entrepreneurial activity in favor of state-owned enterprises and select multinationals, China's 1990s growth did not sufficiently benefit its citizens. "The story of the 1990s is one of substantial urban biases, huge investments in state-allied businesses, courting FDI [foreign direct investment] by restricting indigenous capitalists, and subsidizing the cosmetically impressive urban boom by taxing the poorest segments of the population."

China's current leadership, under President Hu Jintao and Premier Wen Jiabao, has indicated an intention to change course. In fact, many interpret Hu's guiding principle of a "harmonious society," first introduced at the 2005 National People's Congress, as speaking directly to a rebalancing away from export and investment and toward consumption. In a recent report, David Cui, co-head of Hong Kong/China research at Merrill Lynch, contends that Hu aims "to achieve more balanced and sustainable growth that relies more on internally generated drivers." Beijing had started to try to cool the real estate and stock markets as part of this shift from investment to consumption, but the global financial crisis forced it to bin that effort. Instead, the Chinese government spent lavishly on shovel-ready infrastructure projects to support the Chinese and global economies. But this spending funded a number of white elephants: boondoggle infrastructure projects, empty malls, empty cities, and hopelessly uncompetitive industrial capacity hiding under the skirts of local governments.

With the global economy now out of free fall, China's leaders have issued a comprehensive slate of reforms to foster consumption and curb excessive capital investment. Using the full suite of policy tools available to a command economy, the government has removed tax incentives for some exports and added new ones for research and development while directing banks to curb lending and utilities to raise power prices for certain heavy industries. At the same time, new pension schemes, health-care coverage, and even a budding tolerance for collective bargaining with underpaid workers are intended to boost consumption. Although the Chinese authorities have long frowned on labor unrest, they have looked the other way at a recent spate of strikes and demands for higher wages. In fact, in some cases, local authorities have done the collective bargaining for their citizens by mandating higher minimum wages. Higher wages are easy political sells, but several initiatives even centrally plan creative destruction.

One of the more ambitious initiatives appeared on the website of China's Ministry of Industry and Information Technology one Sunday afternoon this August. The ministry lists 2,087 steel, cement, and other factories that must be closed by Sept. 30 of this year.

...

But plant closures are easier announced than done, particularly in the face of increasingly vocal and sometimes violent workers. In summer 2009, the sale of a steel mill owned by the provincial government in Henan province was halted after workers protested. The government preferred to return the $26 million deposit paid by the erstwhile acquirer than risk repeating an incident three weeks earlier where rioting workers beat to death an executive who announced the restructuring of a steel mill in Jilin province. Here, Beijing would be wise to swallow this pill in one gulp, rather than allowing the bitter medicine to slowly trickle down, paralyzing the entire economy as it did in Japan.

If China can tough through these reforms and consolidate inefficient capacity, it will have accomplished much, but to really transition to a domestically led economy, Beijing will need to nurture a competitive service sector. And that's a much bigger ask. There is not yet consensus for such a move as many within China are still wedded to the 1990s growth model. Mei Xinyu, a researcher at the Chinese Academy of International Trade under the Ministry of Commerce, recently wrote that "the manufacturing industry can provide enough jobs to Chinese people and also widely distribute the benefits of economic growth." In fact, the service sector is better at both. The International Monetary Fund (IMF) recently found that the benefits of growth are not distributed equitably to workers in manufacturing-oriented economies; wages tend not to keep pace with productivity gains in countries like China and Japan where productivity in services lags manufacturing badly.

Not that an IMF report makes a lick of difference -- but when wages start lagging and the masses start realizing that their efforts are not being rewarded, then Beijing will have to take action. Yet it will likely have a hard time making such a shift. Dynamic service sectors are not generally compatible with central planning because service economies are naturally discombobulated. Technocrats can calculate where a new bridge or airport will have the greatest positive impact and then build that bridge or airport -- but it is much harder to dictate from on high the creation of the next Facebook or to manifest a thriving small business sector.

In both China and Japan, finance, media, and other key service sectors are seen as too sensitive for free competition, so players with government ties are protected by onerous regulatory barriers to entry. It is not a coincidence that Japan has the lowest service-sector productivity in the G-7 and one of the lowest in the OECD. For their part, China's heavily protected and state-owned banks not only seek to limit their own competitors, but, through their lending practices, also hamper competition in other sectors by giving lower rates to favored, often state-owned, companies. A recent study by Li Cui of the Hong Kong Monetary Authority found that small businesses in China have less access to credit and pay much higher rates than larger companies. A recent article in the IMF's Finance and Development magazine concludes that opening up China's banking market to foreign competition could have sweeping positive effects throughout the economy.

While none of these reforms is easy, China's ticking demographic clock makes them urgent. China's one-child policy produced a large demographic dividend in the 1980s and 1990s as those of working age had fewer dependants to support. Starting in 2015, however, China will suffer the inverse -- a growing number of aged relying on a shrinking pool of young workers. "China has always been a demographic early achiever," quips a recent U.N. population report.

When China's working-age population peaks in 2015, it will be 20 years after Japan's crested the wave, but it will do so at a much lower level of prosperity than was Japan's at that time. The harsh reality is this: Japan got rich before it grew old, and China will grow old before it gets rich.

...

By reminding China's leadership that relying on exports means depending on unreliable foreigners, the [economic] crisis put the pain of rebalancing in perspective. It is not out of altruism that we have seen renminbi appreciation accompanying Chinese wage hikes and other rebalancing measures. A slight loosening of controls over media and finance could be in the offing. Deregulating the service sector might be a frightening political proposition, but perhaps less so than not having one when the exports dry up.

Like I said, go read the whole thing.  And when you finish the article, I'm quite sure that a few things will have become abundantly clear to you, as they did to me:

• First, the Chinese government's currency policies have nothing to do with "preying" on American jobs or crippling the US economy through pernicious trade practices.  Instead, they're the result of an old and increasingly-problematic domestic policy and a ruling class that is trying (so far, unsuccessfully) to get its economy to export less and consume more, but is deathly afraid of screwing up that transition.

• Second, forcing China to significantly strengthen its currency right now would have disastrous effects for the Chinese (and American and European and Japanese and...) economy - something China's leaders, having witnessed Japan's collapse, know all too well.

• Third, China's not nearly the scary economic monster that most people think it is (although it certainly behaves naughtily at times), and could very well collapse in the next decade if its leaders can't figure out a way out of the very big mess they've made.

Some big "manipulator," huh?


*Am I the only one who's noticed that Senator Specter's grave concerns about Chinese trade practices have kinda disappeared since he lost his primary back in May?  Just a crazy coincidence, I guess.

It's Baaaaaack....

After a glorious two-month oasis of silence on China currency, the issue is back with a vengeance.  (I swear, this thing is harder to kill than the Terminator.)  Yesterday, everybody's favorite China-demagogue Sen. Chuck Schumer (D-Campaigning) announced to the US-China Economic and Security Review Commission that he and his Senate colleagues would advance legislation unilaterally attacking Chinese imports unless China appreciates its currency (the RMB) by the end of the June 26-27 G-20 Summit in Toronto.  Reuters details the comments here:

U.S. congressional anger over China's currency and trade practices boiled over on Wednesday as senators vowed to pass legislation soon and lashed out at President Barack Obama's administration for failing to get tough with Beijing.

"Years of meetings and discussions with Chinese officials in an effort to persuade China to float its currency have repeatedly failed to produce lasting and meaningful results," Senator Charles Schumer told the U.S.-China Economic and Security Review Commission, a watchdog group appointed by Congress.

"No question, this is what is called a 'put up or shut up' moment for lawmakers," the New York Democrat said.

Schumer told the commission that he and other colleagues would push for a vote "in the next two weeks" on legislation that would allow the Commerce Department to use anti-dumping and countervailing duty laws against China or any other country with a fundamentally misaligned exchange rate.

He blamed China's undervalued currency for millions of lost U.S. manufacturing jobs and thousands of closed facilities.

Getting Beijing to allow its currency to rise to a more market-oriented exchange rate would do more to create jobs in the United States than any new stimulus package, Schumer said....

Schumer and [fellow protectionist Sen. Lindsay] Graham are expected to offer their bill as an amendment to a broader piece of legislation, rather than try to pass it on its own.

For the bill to be enacted, it would also have to be approved by the House of Representatives and signed into law by Obama.

Schumer and many of his Senate colleagues - from both political parties - echoed such angry sentiments at today's Senate Finance committee hearing with Treasury Secretary Tim Geithner.  (More on that here, along with some fantastic commentary from some trade lawyer wearing way too much makeup.)  Oh, goody.

Now, I've already laid out in excruciating detail how silly and wrongheaded all of this hyper-political pabulum is from an economic, historical, legal and practical perspective, and the Senators' rhetoric remains par for the course.  Heck, I even predicted last month that those precious weeks of silence on the China currency "debate" would end right about now as these pols resumed their China attacks in preparation for the November midterm elections.  However, a few things have changed since the last time China currency was in the news (i.e., March-April of this year) which make this week's silly rhetorical flurries a little more noteworthy.

First, Greece imploded and took the Euro with it.  Back in April, pretty much everyone "in-the-know" (or at least who unwisely thinks he's i-t-k - like me) was expecting China to allow a one-off RMB appreciation of about 5% sometime right before the G-20 Summit.  Indeed, the DC tea leaves were saying that the G-20 "deadline" was the main reason that the Treasury Department delayed its semi-annual currency report.  But then the Euro collapsed and made everything a lot more complicated.  The EU, afterall, is China's top trading partner, and China is the EU's #2.  So with the Euro falling to levels not seen in years, and with the global currency markets ridiculously unstable right now because of it, the Chinese government is probably going to hold off on any RMB movement until things settle down a bit.  And you really can't blame them.

Second, China announced yesterday that its exports in May surged 48.5% year-on-year, and its trade surplus returned to pre-recession levels (a rather large $20 billion/month).  Imports into China rose by 48.3% too, but let's face it: nobody really cares about that because May's surplus statistics are definitely going to stall (or thwart entirely) any of those budding conclusions that China's tiny April surplus and March deficit signaled that the Chinese economy was finally becoming more consumption-oriented.  Now, given the EU mess, nobody really knows what's going on with China or anywhere else for that matter, but there's no doubt that China's May trade data are going to fuel the congressional currency hawks' fire.  As Patrick Chovanec eloquently put it: "by knocking the legs out from under Chinese arguments that a structural adjustment is taking place without Renminbi appreciation, China’s May export surge is likely to feed into growing US impatience over China’s hesitation in moving on the exchange rate."  Indeed.

Third, the US announced today that is April trade deficit increased 0.6% to $40.29 billion from a revised $40.05 billion in March.  From a purely economic perspective, these new data are pretty bad news: both exports and (non-oil) imports fell - a sign that US economic recovery just isn't ramping up.  But the stats are also unwelcome from a political perspective two reasons: (i) the currency hawks can scream "DEFICIT!" and most people (including a lot of bad journalists) aren't going to know that the US trade deficit's growth was driven entirely by higher energy prices; and (ii) the US trade deficit with China - which is an economically worthless, yet politically effective number - expanded significantly to $19.31 billion in April from $16.90 billion in March.  Yet another thing to point and scream about.

The combination of these three developments, a struggling US economy, and the November midterm elections is definitely going to push China's currency back to the forefront of the 2010 international trade stage and maybe, just maybe, create the perfect political storm to blow some piece of nasty currency legislation across the House or Senate finish line.  Now, I still don't expect any such legislation to ever pass both chambers and make it all the way to President Obama's desk, but I do think that we all should gird our loins for one hot, sticky (and terribly annoying) "Summer of Schumer."

Ugh.

Obama Administration Wears Velvet Gloves in Beijing

It's kinda amazing that less than two months ago the punditocracy was openly kvetching about the strong possibility of a US-China trade war.  I wasn't buying it, but I must say that even I'm a little surprised at how quickly the tone from the Obama administration (and its Party faithful) has changed.  Take this story from today's FT on the US-China Strategic and Economic Dialogue (S&ED), which started today:

China has made progress in rebalancing its economy towards domestic consumption and away from exports even though its currency remains pegged to the dollar, Tim Geithner, US Treasury secretary, said as he prepared for the start of the annual US-China summit.

Adopting a conciliatory tone on Sunday ahead of two days of meetings in Beijing starting on Monday, Mr Geithner said China had relaxed some of the restrictions facing multinationals that have angered parts of the US business community in China....

The US has long been pressing China to rebalance its economy by adopting a stronger currency, especially since the renminbi was re­pegged to the US dollar in mid-2008. But Mr Geithner admitted that Chinese government policies were reducing its dependence on exports.

He said: “It looks as if there has been a durable shift towards domestic consumption in China. Domestic demand is growing more rapidly than [gross domestic product], and there’s been a big drop in the external surplus.”

China’s current account surplus dropped from 11 per cent of GDP in 2007 to 5.8 per cent last year as its aggressive stimulus plan drew in record imports of commodities.

The US administration is likely to soft pedal over the currency issue in public this week, for fear of provoking a backlash from its hosts in Beijing.

But officials acknowledge that if China has not shifted policy by the G20 summit in late June, political pressure will rise in the US for trade measures directed at China.

The US will also lobby China over a series of new rules that some foreign businesses in China say are making it harder for them to operate. Mr Geithner acknowledged, however, that China had changed so-called “indigenous innovation” rules introduced last year, which multinationals claimed would exclude them from public procurement contracts.

I'd like to think that this is a case of sanity finally prevailing over political nincompoopery, but I'm quite sure that the politics of China-bashing ain't dead for this year.  Instead, it's just taking a little nap so key administration officials can pleasantly meet in Beijing with their Chinese counterparts and so the Chinese can appreciate the RMB against the Dollar in advance of the June G-20 summit without appearing to do so because of intense foreign pressure (the Chinese have their own domestic political pressures, you know).  However, when (not if) the Chinese let their currency strengthen a little, it certainly won't be enough to satisfy the currency hawks in Congress who will gladly demagogue the issue all the way to the November midterms.  So it's all but certain that, contrary to what the FT article says above, the politics of US-China trade aren't going to get any better once the RMB appreciates by a measly old 5% (or less).  Nope, only an election can cure what ails the currency crazies.  So sanity should just enjoy its little moment in the sun right now, because it's going back in the closet very soon and probably won't be back 'till mid-November at the earliest.

Now let's just hope that, in the meantime, nobody does anything supremely stupid to make the whole US-China trade relationship actually go off the rails.

Geithner's Delay of Currency "Manipulation" Report Might Be Smart, but Is It Legal?

On Sunday, I noted that Treasury Secretary Tim Geithner formally announced that he would delay by several months the Department's April 15 report on foreign countries' currency practices.  Upon hearing of the announcement, I and everyone else immediately put on our wonk hats, and breathlessly analyzed the decision and its policy implications.  However, AEI's Phil Levy recently emailed me a simple, but equally important, question that thus far appears to have been totally ignored by the administration, Congress and the chattering classes (myself included):

Is Geithner's decision to delay the currency report legal?

Well, from a quick review of the law, it appears that it was not.  As I've noted before, the Treasury report (the "Semi-Annual Report to Congress on International Economic and Exchange Rate Policies") must, by law, be published twice per year.  The Report's requirements are set forth in Sections 3004 and 3005 of the Omnibus Trade and Competitiveness Act of 1988.  Section 3005 (22 U.S.C. 5305) in particular states (emphasis mine):

(a) Reports Required.– In furtherance of the purpose of this title, the Secretary, after consultation with the Chairman of the Board, shall submit to the Committee on Banking, Finance and Urban Affairs of the House of Representatives and the Committee on Banking, Housing, and Urban Affairs of the Senate, on or before October 15 each year, a written report on international economic policy, including exchange rate policy.

The Secretary shall provide a written update of developments six months after the initial report. In addition, the Secretary shall appear, if requested, before both committees to provide testimony on these reports.

In legalese, the term "shall" denotes the mandatory, not the permissive.  It is a requirement, and there are no exceptions in all of Section 3005 that would limit this imperative.  (Paragraph (b), the only other paragraph, of Section 3005 sets forth the content requirements for the currency report.)  In short, US law requires the Treasury Secretary to submit a currency report to Congress on October 15 of every year, and then six months later (i.e., April 15), without exception.

The last report was issued on October 15, 2009.  On the very first page of the report, it states "This report reviews developments in international economic and exchange rate policies, focusing on the first half of 2009, and is required under the Omnibus Trade and Competitiveness Act of 1988, 22 U.S.C. § 5305 (the 'Act')."  As noted above, that law requires the Secretary to submit the next currency report six months later - i.e., on or before April 15, 2010.  Without exception.  Indeed, last April's report reiterates this express legal requirement (again on p. 1).

Thus, there can be no question that Geithner's formal delay of the Treasury Report expressly violates US law.  Granted, the Bush Administration routinely delayed the currency report, but it did so very quietly.  Indeed, I can't recall the administration ever releasing a formal announcement of its intent to violate the reporting requirements of US law.  And Geithner's April 3 announcement of the report's delay makes no mention of the legal requirement - only the Secretary's decision.

Of course, the practical implications of this legal revelation are likely quite small - I can't imagine a congressional currency hawk or free trader vocally demanding that Geithner issue the report pursuant to the explicit legal mandate.  Nevertheless, it's important to note that not only is the White House "voting present" on the China currency issue, it's doing so in express violation of US law. 

(And I'll let you add your own commentary about whether this move is indicative of a broader trend for the Obama administration re: its respect, or lack thereof, for the rule of law.)