Global Trends by Martin Khor

Monday 4 October 2010

Tensions rise as US bill targets China

The trend towards new protectionism accelerated last week as the US Congress passed a bill to direct the administration to allow easier action against China and other countries found to manipulate their currency. 

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Yet another step towards new trade protectionism was taken in the United States last week when the House of Representatives passed a bill enabling the government to raise tariffs of products from countries deemed to have “fundamentally manipulated” their currencies.

The bill is clearly aimed at China, which many in the US Congress and administration believe is deliberately keeping its currency at a low value in order to boost exports.  But it does not specifically name China and it could be used also against other countries.

The bill, passed by a vote of 348-79 on 29 September, will not become law unless it is also passed by the Senate and agreed to by President Barrack Obama. 

There is speculation that these two other steps are not so likely, and that the House bill is more of a threat in order to increase pressure on China to get the yuan to appreciate much more.

Many American politicians blame the US trade deficit on what they consider a grossly under-valued yuan.  The economist Paul Krugman has called for slapping an extra 25% tariff on Chinese products.

With the Congressional elections on 2 November approaching, many politicians of both parties have intensified their China-bashing, and Obama also made the Chinese currency his top priority topic when he met Chinese premier Wen Jeibao in New York a fortnight ago.

With such a mood, trade sanctions against Chinese products on currency grounds could well become a reality soon.

Currency is the latest in a series of new reasons being prepared, to block imports.  Last month the steel workers' union petitioned the US administration to take a case in the WTO against Chinese solar energy and wind energy products on the ground that local companies were getting export subsidies.

Last year the House of Representatives passed a climate change related bill that included a section directing the President to impose border adjustment measures (a financial charge or levy) on selected imports from countries that do not conform to US standards of adequate action to reduce emissions. 

China has reacted strongly to the currency bill.  A Foreign Ministry spokesperson said China opposed the bill and warned that using the yuan exchange rate to engage in trade protectionism can only harm China-US trade and economic relations and the world economy.  And a Commerce Ministry spokesman said that “carrying out anti-subsidy investigations on the basis of currency is against the rules of the WTO.”

An economist at the Chinese Academy of Social Sciences, Zhang Xiaojing commented:  “It marks a formal step towards a trade war.”  

While some US economists blame the Chinese currency, other economists (American and non-American) point out that the United States' economic problems stem from other more important factors, and that even a large appreciation of the yuan against the dollar would not solve the US problems.

For example, a recent South Centre paper on global economic prospects was skeptical that dollar depreciation against the Chinese currency would address the root cause of the US problem of over-consumption.

It is unlikely to produce significantly faster growth of exports to China. Even if it reduces China's exports to the US, this may be replaced by imports from other developing countries as long as US consumers continue to live beyond their means.

The paper pointed out that the US has run current account deficits in the past four decades regardless of the strength of the dollar against the currencies of its main trading partners, blaming Germany in the 1970s, Japan in the 1980s and now China. The yen has been rising against the dollar during this period but this had no impact on the surplus of Japan with the US.

The bill directs the US Commerce Department to treat “fundamentally undervalued” currencies as an export subsidy,  so that action can be taken against the countries' products. 

This is counter to the Department's practice of rejecting requests to investigate China's under-valued currency as an export subsidy, on the ground that exporters are not the sole beneficiaries of the “subsidy” complained about (because for example local producers also benefit from the over-valued currency).

The bill thus removes a barrier, and passed into law, it will strengthen complaining U.S. companies'  chances to get countervailing duties imposed on Chinese products.

To succeed, the companies would have to show they have been harmed or face the threat of serious harm by imports from the countries being blamed.

The bill defines a currency as being “fundamentally undervalued” if the government has engaged in  protracted, large-scale currency intervention in a foreign exchange market during an 18-month period; if the real effective exchange rate is undervalued by at least 5 percent over the period; if the country has had significant and persistent current account surpluses during the period; and if the foreign reserves held by the government during the period exceeds the amount necessary to repay its debt obligations within the next 12 months, exceeds 20% of the country's money supply and exceeds the value of the country's imports during the previous four months.

If action is taken under this bill, a key question would be whether it is compatible with the WTO's laws. The bill's advocates claim it is, while China thinks otherwise.

Whatever a WTO panel may decide in a future case, such an action would cause enormous damage to China-US economic relations.

Chinese Premier Wen Jiabao recently defended his country's currency policy, pointing out that the yuan had appreciated by a massive 55.2% from January 1994 to July 2010.

Saying that the yuan had seen increased flexibility since June when China launched further reforms of the yuan exchange rate mechanism, he added that China was still facing great difficulties and there was no basis for drastic appreciation.

Ian Lamont, a MIT Sloan fellow, in a blog article, has analysed why increasing the yuan's value runs counter to Beijing’s domestic priorities of preserving economic growth and domestic stability.

He predicts that even a slight uptick in the yuan would result in a drop in Chinese exports and put marginal factories out of business and put their workers on the streets, while other companies would shift their low-wage manufacturing to Vietnam and Sri Lanka.

And in the event of a sharp rise in the yuan, there could be extreme economic disruption, accompanied by social and political turmoil, widespread domestic instability, and an exodus of migrants.

A Xinhua agency report, which seems to corroborate Lamont's analysis, said that even the 2% yuan rise since June has caused significant difficulties to some exporters already facing increased wages and higher costs.

A Xinhua survey in the provinces of Guangdong, Zhejiang, Jiangsu and Shandong, China's leading exporting areas, in September found that a sharp increase in the yuan's value could send many Chinese exporters to the wall.

It found that the profit margin for labor-intensive exporters' industry such as producers of textiles, garments, footwear, toys and auto parts has dropped below 5 percent this year, leaving little room for those companies to afford a stronger yuan.

Every percentage point rise of the yuan's value in real terms equalled a 0.63-percentage-point reduction in the volume of exports of machinery and electronic products, and a 1.47-percentage-point contraction in exports of textiles and garments, according to a study by the Jiangsu Provincial Academy of Social Sciences and the province's Department of Commerce.

Xu Weimin, president of Jiangsu Dongdu Textile Group Co Ltd, said the general textile industry's average profit margin was between 3 percent and 4 percent.  "If the yuan rises by more than 5 percent, about two thirds of textile companies will lose,"

The obsessive conviction by US politicians that their country's economy's woes are caused by China and specifically its currency, and the serious problems on the ground in China that would be caused by an appreciation of the yuan are two factors that make the successful resolution of the US-China standoff difficult.

This explains the dangers of new and growing protectionism in the US and the angry response in China.   Hopefully the House bill in the US will not progress into law and subsequent action.  But it may, and we should brace for tough times ahead.