May You Live in Interesting Times: Looming Conflict with China

Philip I. Levy

May 24, 2010

U.S. economic relations with China

What happened this year? Forces driving the U.S. debate Forces driving China Policy options and perils

What in the world…?

Landmarks of the last year– China’s not a currency manipulator, but the currency

does not budge– The Group of 20 (G-20) pledges to rebalance the

global economy– Trade deficits shrink– U.S. protection irritates China

What in the world…?

Landmarks of the last year– China’s not a currency manipulator, but the

currency does not budge– The Group of 20 (G-20) pledges to rebalance the

global economy– Trade deficits shrink– U.S. protection irritates China

One episode of appreciation

What in the world…?

Landmarks of the last year– China’s not a currency manipulator, but the currency

does not budge– The Group of 20 (G-20) pledges to rebalance the

global economy– Trade deficits shrink– U.S. protection irritates China

World Current Account Balance in 2009billions of dollars, IMF World Economic Outlook, April 2010

What in the world…?

Landmarks of the last year– China’s not a currency manipulator, but the currency

does not budge– The Group of 20 (G-20) pledges to rebalance the

global economy– Trade deficits shrink– U.S. protection irritates China

U.S. Monthly Trade Deficitbillions of dollars, annual rate, U.S. Census Bureau

The politically significant number

The politically significant number

China’s global imbalance

U.S. protection irritates China

Persistent irritation about “Buy America” Annoyance at increased use of antidumping

and countervailing duty– Though the Obama administration had no choice

Outright anger at the Section 421 safeguards case on Chinese tires– Though the Obama administration tried to split the

difference

Forces Driving the U.S. Debate

UnemploymentPoliticsThe need for

cooperation

U.S. unemployment rateBureau of Labor Statistics, 2008 to present

0.0

2.0

4.0

6.0

8.0

10.0

12.0

Un

em

plo

ym

en

t R

ate

Experts chime in

Competing claims on how badly the U.S. has been hurt– Fred Bergsten: 1.0 million jobs lost– Paul Krugman, NYT: 1.4 million jobs lost– Rob Scott, EPI: 2.4 million jobs lost

Bergsten: persuading China to boost the value of its currency would be "by far the most cost-effective possible step to reduce the unemployment rate and help speed economic recovery" in the United States.

U.S. Manufacturing Employment

From 2005-2008 when the RMB was rising, ultimately by 20 percent or so, there was no increase in U.S. manufacturing employment at all (and deficit grew).

Virtually all wealthy countries have seen a long-term decline in manufacturing employment. The same thing has happened in Europe and most of Asia. Trends are not different in chronic trade-surplus countries like Japan.

Contrarian: Ray Fair, Yale

The U.S. gained 57,000 jobs from Chinese currency undervaluation.

He sees increased demand for U.S. goods as Chinese imports become more expensive. But offsetting effects as well: decreased Chinese output and imports; increased U.S. prices; decreased U.S. wealth and wages; increased U.S. interest rates. He finds the latter effects more than outweigh the former.

Political imperative

JOBSElections looming in November

Important interactions with China

Potential for war on the Korean peninsula U.N. sanctions on Iran Global climate talks G-20 summitry Important financier for U.S. borrowing

Forces Driving China

A new haughtiness

PoliticsEconomic

uncertainty

China’s growth performanceIMF - estimates beyond 2008

0

2

4

6

8

10

12

14

2003 2004 2005 2006 2007 2008 2009* 2010* 2011* 2012* 2013* 2014* 2015*

Year

Perc

enta

ge g

row

th R

ate

Chinese politics

Leadership change in 2012 Legitimacy through economic achievement and

nationalism, no longer ideology Division on currency

– People’s Bank leads charge for currency appreciation

– Ministry of Commerce leads charge against

No one wants to appear weak

China’s worries

Excessive bank lending Inflation

– Reports of annual property inflation over 50% in Beijing and Shanghai, links to past unrest

Stock bubble– The Shanghai Composite Index has declined 17 percent this

year, the world's second-worst performer among the 93 gauges tracked by Bloomberg (China Daily, last week)

Europe– China’s biggest export market: 19.7 percent – Lending and export freeze redux (threat of unemployment)

One episode of appreciation

A different perspective: cross-rates

yuan/euro

The clock is ticking

House Ways and Means Chairman Sander Levin:If China fails to increase the value of its currency by the last week of June, the Obama administration and the U.S. Congress will be forced to take unilateral steps in response.

What would we like China to do?

Quick, one-shot appreciation: 25-40 percent– May cause turmoil within Chinese economy– Financial system ill-prepared for major resource

shift

Gradual appreciation, e.g. 6 percent per year– Follows precedent– No dramatic short-term effects

American Chamber of Commerce - Shanghai survey

Today’s News from Beijing

President Hu Jintao:– “China will continue to steadily advance reform of the renminbi

exchange rate formation mechanism following the principles of being independent, controllable and gradual.”

Secretary Tim Geithner:– “We welcome the fact that China’s leaders have recognized

that reform of the exchange rate is an important part of their broader reform agenda.”

Interpretation:– Zhang Xiaoqiang, vice chairman of the National Development

and Reform Commission: China’s “basic principles” of exchange rate policy were unchanged. (Financial Times)

Policy options on the table

1. Wait patiently for China to change

2. Try to reach multilateral agreement on rules for exchange rate behavior

3. Name China a currency manipulator

4. Press a case at the WTO

5. Use countervailing duty measures

6. Apply a unilateral tariff, perhaps 25 percent

What happens next?

Open for discussion!