No time for trade war

Pushing China into revaluing its currency risks toppling the global recovery from its stabilising axis. Instead, Washington should face the crisis it created on its own.

The battle with the US over China’s exchange rate continues. When the Great Recession began, many worried that protectionism would rear its ugly head. True, G-20 leaders promised that they had learned the lessons of the Great Depression. But 17 of the G-20’s members introduced protectionist measures just months after the first summit in November 2008. The Buy America provision in the US’ stimulus bill got the most attention. Still, protectionism was contained, partly due to the World Trade Organization.

Continuing economic weakness in the advanced economies risks a new round of protectionism. In the US, for example, more than one in six workers who would like a full-time job can’t find one.

These were among the risks associated with the US’ insufficient stimulus, which was designed to placate members of Congress as much as it was to revive the economy. With soaring deficits, a second stimulus appears unlikely, and, with monetary policy at its limits and inflation hawks being barely kept at bay, there is little hope of help from that department, either. So, protectionism is taking pride of place.

The US Treasury has been charged by Congress to assess whether China is a ‘currency manipulator’. Although President Barack Obama has now delayed for some months when Treasury secretary Timothy Geithner must issue his report, the very concept of currency manipulation is flawed: all governments take actions that directly or indirectly affect the exchange rate. Reckless budget deficits can lead to a weak currency; so can low interest rates. Until the recent crisis in Greece, the US benefited from a weak dollar-euro exchange rate. Should Europeans have accused the US of ‘manipulating’ the exchange rate to expand exports at its expense?

Although US politicians focus on the bilateral trade deficit with China — which is persistently large — what matters is the multilateral balance. When demands for China to adjust its exchange rate began during George W Bush’s administration, its multilateral trade surplus was small. More recently, however, China has been running a large multilateral surplus as well.

Saudi Arabia also has a bilateral and multilateral surplus: Americans want its oil, and Saudis want fewer US products. Even in absolute value, Saudi Arabia’s multilateral merchandise surplus of $212 billion in 2008 dwarfs China’s $175 billion surplus; as a percentage of GDP, Saudi Arabia’s current-account surplus, at 11.5% of GDP, is more than twice that of China. Saudi Arabia’s surplus would be far higher were it not for US armaments exports.

In a global economy with deficient aggregate demand, current-account surpluses are a problem. But China’s current-account surplus is actually less than the combined figure for Japan and Germany; as a percentage of GDP, it is 5%, compared to Germany’s 5.2%.

Many factors other than exchange rates affect a country’s trade balance. A key determinant is national savings. US’ multilateral trade deficit will not be significantly narrowed until America saves significantly more; while the Great Recession induced higher household savings (which were near zero), this has been more than offset by the increased government deficits.

ADJUSTMENT in the exchange rate is likely to shift to where the US buys its textiles and apparel: from Bangladesh or Sri Lanka, rather than China. Meanwhile, a rise in the exchange rate is likely to contribute to inequality in China, as its poor farmers face increasing competition from the US’ highly subsidised farms. This is the real trade distortion in the global economy, one in which millions of poor people in developing countries are hurt as the US helps some of the world’s richest farmers.

During the 1997-98 Asian financial crisis, the renminbi’s stability played an important role in stabilising the region. So, too, the renminbi’s stability has helped the region maintain strong growth, from which the world benefits.

Some argue that China needs to adjust its exchange rate to prevent inflation or bubbles. Inflation remains contained but, more to the point, China’s government has an arsenal of other weapons — from taxes on capital inflows and capital-gains taxes to a variety of monetary instruments — at its disposal.
But exchange rates do affect the pattern of growth, and it is in China’s interest to restructure and move away from high dependence on export-led growth. China recognises that its currency needs to appreciate over the long run, and politicising the speed at which it does so has been counterproductive. (Since it began revaluing its exchange rate in July 2005, the adjustment has been half or more of what most experts think is required.) Moreover, starting a bilateral confrontation is unwise.

Since China’s multilateral surplus is the economic issue and many countries are concerned about it, the US should seek a multilateral, rules-based solution. Imposing unilateral duties after unilaterally labelling China a currency manipulator would undermine the multilateral system, with little payoff. China might respond by imposing duties on those American products effectively directly or indirectly subsidised by the US’ massive bailouts of its banks and car companies.

No one wins from a trade war. So, the US should be wary of igniting one in the midst of an uncertain global recovery — as popular as it might be with politicians whose constituents are justly concerned about high unemployment, and as easy as it is to look for blame elsewhere. Unfortunately, this global crisis was made in the US, and the country must look inward, not only to revive its economy, but also to prevent a recurrence.

(The author is University Professor at Columbia University and recipient of the 2001 Nobel Prize in Economics)