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About Sanctioning China (and Then Being Sanctioned by China)

How Not to End Chinese Currency Manipulation
24 March 2010

by Daniel Michaeli

The Chinese Renminbi, whose largest denomination remains 100 yuan ($14.64)

In the recent hoopla about sanctioning China for currency manipulation, there are a few factors that are being overlooked. These factors suggest that sanctioning Chinese exports won’t help the United States achieve the economic results one would hope to achieve.

To begin with, the goal should be reducing the trade deficit with China not for its own sake, but to produce more jobs in the United States. (After all, this is why China’s currency manipulation matters.)

So U.S. companies need to find more demand for products they produce, either here or elsewhere around the world. Yet if the U.S. slaps a 25% tariff on Chinese goods, it might as well give up on selling much at all to China’s 1.3 billion-person market.

The assertive stance taken by China’s prime minister Wen Jiabao last week revealed two important realities. First, it reflected how China will respond to any sanctions move by the United States. Chinese leaders have been leaning mercantilist in recent years, itching to build up their state owned enterprises at the expense of foreign companies.

So in response to American tariffs, they would almost surely take the opportunity to wall off more of China’s domestic market for its own companies–by imposing countervailing duties on American exports to China, which was the third-largest U.S. export market in 2009, absorbing about 6.6% of our exports. Wen’s assertion that U.S. pressure on China’s currency “is a type of trade protectionism” suggests that China will use this logic to justify a countervailing response to any “protectionist” U.S. actions (like last September). China’s commerce minister, Chen Deming, warned yesterday that China “will not sit back” should it face sanctions.

Second, Wen’s words hinted at the reality that giving in to American pressure would be seen as a sign of weakness in China, and is therefore politically difficult for a Chinese government that wields power largely through Han Chinese nationalism.

The Chinese sense of wounded pride goes very deep. From birth, the story Chinese people are taught is: China was taken advantage of by Western powers through a century of shame, but now it is rising again. The Chinese Communist Party works hard to perpetuate this narrative. The brochures given to attendees of the 2008 Beijing Olympics (myself included) said foreigners were prohibited from peddling opium, a strange throwback to the Opium Wars of the nineteenth century. (See this excellent article from the New York Review of Books for more on Chinese insecurities with its history.)

What would be the other consequences of trade sanctions?

Half of Chinese exports in recent years have been produced by non-Chinese companies manufacturing in China. In other words, a surcharge on imports would make products from iPhones to LensCrafters eyeglasses costlier in the United States, which would put a significant dent in the earnings of many major U.S. companies, not only Chinese ones. This would, of course, also reduce American purchasing power–but maybe that’s not such a bad thing, since Americans have been living beyond their means for a long time.

Then there’s the fact that most manufacturing migration would go to other developing countries in Asia and Latin America, which could still produce these goods more cheaply than in the United States. This is already the trend, since labor costs have spiked in China in recent years.

Would manufacturing of any China-produced products migrate back to the United States? If so, how many new jobs would be created?

Fred Bergsten writes that correcting all Asian undervaluations would generate at least 700,000 jobs in the United States and cut the trade deficit by $100 billion. But this is unlikely for a host of reasons. Here’s one: sanctioning China provides little incentive to other Asian countries to revalue their currencies. (And it is hard to imagine the U.S. sanctioning all of Asia based on the judgment of even the best economists on the proper valuation of foreign currencies.)

So importing $100 billion less from China, more likely than not, simply means shifting the source of the same imports–which now would cost slightly more than $100 billion, since they come from other countries that manufacture slightly less cheaply than China (but still far more cheaply than the United States). This, ironically, actually increases the U.S. trade deficit.

And, more significantly, here’s the other reason Bergsten is off the mark: he assumes that the United States will be more competitive in the Chinese market after a revaluation. This might be true if China revalues voluntarily. But if China is somehow forced into a revaluation through American sanctions, it would be naïve to expect that the Chinese will respond by welcoming U.S. imports.

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