Tax Analysts Blog

On China Policy, Be Careful What You Ask For

Posted on Nov 17, 2009

Nobody likes the sound of a "weak" dollar. But it provides the economy with a lot of benefits. Most importantly, it makes U.S. exports cheaper for foreign purchasers--boosting U.S. trade. This is why U.S. manufacturers and their employees are mad as hell that China does not allow its currency to appreciate against the dollar. Most experts agree that the value of China's currency is being artificially supported by the government. The Chinese government, they say, should let its currency (alternately called the "renminbi" or the "yuan" in English) float. And so does the U.S. Secretary of Treasury, as you can hear in this November 12 interview on CNBC.

The Chinese like keeping their currency "weak" for the same reasons we would like it to appreciate. They want to increase their exports and their job growth. Most U.S. advocates of a stronger renminbi simply ignore Chinese domestic considerations that drive Chinese policy. One exception is Robert Reich writing in today's Wall Street Journal:

    To this extent, China's export policy is really a social policy, designed to maintain order. Despite the Obama administration's entreaties, China will continue to peg the yuan to the dollar—when the dollar drops, selling yuan in the foreign-exchange market and adding to its pile of foreign assets in order to maintain the yuan's fixed relation to the dollar. This is costly to China, of course, but for the purposes of industrial and social policy, China figures the cost is worth it.
A few years ago I made this same point in an article forTax Notes ("U.S. Pork and the Price of Tea in China," June 13, 2005):
    Any revaluation of the renminbi would be a major blow to the 365 million who are still working on farms. Just weeks ago the London Daily Telegraph reported Japan's vice finance minister for international affairs, Hiroshi Watanabe, saying that China faces the risk of a peasants' revolt (in the words of the Daily Telegraph) as it prepares to revalue its currency. Watanabe explained: "Let's not forget that China's agriculture is very uncompetitive and would risk being driven onto the ropes by imports of foreign food. Beijing cannot allow a surge in the numbers of unemployed farm workers, especially at a time when coastal industry is absorbing less manpower."
Besides it not being in China's interest, one fact that fascinates me is how U.S. policymakers ignore the possibilty that appreciation of the renmimbi may not always be in our interest. China controls its exchange rate by buying and selling U.S. Treasury securities. To get its currency to rise in value, the Chinese government would have have to stop buying U.S. debt. When the U.S. Treasury Secretary tells China to let the renminbi rise, it is exactly the same thing as telling China to stop buying U.S. government securities.

If the Obama Administration is successful in its current efforts to browbeat China, it would on the one hand reduce the value of the dollar, but by the same mechanism it would also be pushing up U.S. interest rates. So what would a renminbi revaluation mean for the United States? In brief, trade- sensitive sectors -- like manufacturing and agriculture -- would benefit. Interest-rate sensitive sectors -- like housing and the federal government itself -- would suffer.

Interest costs on the federal debt are projected to skyrocket over the next decade. This may not be the best time to be chasing away the borrower that has kept interest rates so low for the last decade. The Obama administration is supposed to begin its big push on deficit reduction with the President's State of the Union speech in January.

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