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April 25, 2005

Prepare for Boredom: HCB on Chinese Monetary Policy & Trade

[Note: this isn't really a standard hcb-style posting, but it's boring enough (to many) that I thought I'd put it here instead of my bread & butter blog.]

On the one hand, I've got to give Chuck Schumer a lot of credit for pushing legislation to put some pressure on China to revalue the renminbi. Historically, the democratic party isn't the one that's most likely to crow about international monetary policy. The problem is that it's just not in America's best interests for China to revalue. At first blush, it may seem like the reason we have such a huge trade deficit with China is because, by maintaining their dollar peg at its current rate, they're making their goods so cheap for us that we can't help but buy them. The thinking then, is that a more realistic peg, or even a floating yuan would make Chinese goods less attractive to US consumers, and so narrow the trade gap somewhat.

There's nothing wrong with that reasoning as far as it goes, but it omits one important point. China has the world's highest concentration and largest amount of dollars in its forex reserves. This is mostly an effort to prop up the dollar. If China revalued or let her currency float, she would have no reason to artificially bolster the dollar, and would likely sell off many of its US currency reserves. A sell-off by China would cause other Asian nations to follow suit, with the result that the already ailing dollar would bottom out.

This is to say nothing of the fact that any unilateral action by the US against China on matters of trade and currency would surely fall in breach of the WTO. In order for the US strategy to pass WTO muster, we would have to demonstrate that China is manipulating its currency to keep it artificially low. Considering the Renminbi has a stable peg, that would be more than a little difficult to show.

Joseph Stiglitz and Lawerence Lau put forward an interesting alternative to revaluation in today's FT (Paid subscription required. Just pick up the print edition if you're interested. There's also an interesting comment piece on what the EU could do in the wake of a 'Non' in the French referendum on the EU Constitution at the end of the month). Their idea is that China should impose a tax on all exports. It would cool growth in their domestic manufacturing sector, thereby encouraging its trading partners (especially the US, EU, and Japan) to back off, and it would generate some revenue for the state.

We can't let the "obvious" (i.e. politically popular) solution to our widening trade gap with China get in the way of our big-picture thinking. If we're going to push China (which isn't necessarily wrong), we should be mindful what we're pushing her towards.

Posted by matt at April 25, 2005 04:55 PM

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