Commentary: On the Yuan, Be Careful What You Wish For

There's a dangerous fantasy taking hold in Washington: The U.S. can force China to strengthen the yuan. Since the beginning of September the Chinese currency has appreciated about 1.8 percent against the dollar; China may be allowing it to drift higher to stave off American retaliation. Bills pending in the House and Senate would push the Administration to penalize Beijing through tariffs if it doesn't let the yuan rise further. "At a time when the U.S. economy is trying to pick itself up off the ground, China's currency manipulation is like a boot to the throat of our recovery," Senator Charles E. Schumer, a New York Democrat and sponsor of one of the bills, said at a congressional hearing this month.

Washington's emphasis on the yuan's value is understandable. It's a conspicuous, trackable indicator of the bilateral relationship. A stronger yuan would shrink the trade imbalance by making American goods more competitive and would help China by suppressing domestic inflation.

Ultimately, though, trying to muscle China into revaluing the yuan would be a mistake. If the U.S. punishes China in ways that aren't allowed by the World Trade Organization, it could risk a trade war, lose the support of other nations, and damage the free-trade system it has worked for decades to develop. By putting so much energy into pushing the yuan upward, the U.S. has less to spend on other critical issues, such as China's discrimination against high-tech imports. And higher inflation in China is already pushing up the yuan's inflation-adjusted value, which is what matters for trade flows. China's global current-account surplus is on track to fall from 10.7 percent of gross domestic product in 2007 to just 2.7 percent in 2011, Deutsche Bank (DB) economists estimated on Sept. 22. "The narrow focus on the currency is misguided," says Joanne L. Thornton, an analyst at Concept Capital's Washington Research Group. "You have to look at the broad landscape of issues."

China has played it smart. Its authorities have been slow to act on U.S. trade complaints, but they have mostly avoided clear-cut violations of WTO rules. If the U.S. retaliates in a way that's contrary to those rules, it could find itself identified as the bad guy.

One House bill that might run afoul of the WTO was introduced by Representative Tim Ryan, an Ohio Democrat, and Tim Murphy, a Pennsylvania Republican. (It has 150 co-sponsors—proof that everyone sees a political win in bashing China in an election year.) The Ryan-Murphy bill would amend the Tariff Act of 1930 to require the Administration to consider exchange rates when investigating allegations of subsidies or dumping. A currency would be considered undervalued if it was as little as 5 percent below its estimated fair value—a hair trigger that would be hard to defend given there's no precise way to calculate the "correct" value of currencies. Schumer's bill would give the Administration more discretion on whether to prosecute a case, but it's still based on the untested theory that currency undervaluation is a legitimate target for countermeasures. Ira Shapiro, a trade lawyer at Greenberg Traurig who was general counsel to the U.S. Trade Representative under President Bill Clinton, testified before Congress on Sept. 15 that he was "very doubtful" the WTO would allow such an approach. (On Sept. 22 the bill was tweaked in ways its sponsors say will better pass muster at the WTO.)

Hard-liners on China aren't troubled by what the WTO might think. They say the Chinese have more to lose from a trade war, so if push comes to shove, the Chinese would back down. They note that in 1971, President Nixon unilaterally imposed a 10 percent tariff on U.S. imports to prop up the dollar. "No gunboats appeared in New York Harbor then, and they wouldn't today," says Ian Fletcher, an adjunct fellow of the U.S. Business & Industry Council, which represents small American manufacturers. On Sept. 10, Paul R. Krugman, the Princeton University economist and New York Times columnist, repeated his call for a temporary tariff to offset the yuan's undervaluation.

Other economists say the U.S. would suffer greatly in a trade war. China is a growing market for American exports. Eswar S. Prasad, a Cornell University professor of trade policy who was chief of the International Monetary Fund's China division, says tariffs might make Chinese leaders less compliant, not more. Their grasp of power is more tenuous than it appears in the West, Prasad says, and to avoid civil unrest, the leadership must demonstrate that it won't be pushed around: "If they're seen as being slapped, they would have to retaliate." China, he says, could undermine U.S. interests through a kind of underground trade war using hard-to-detect measures that discriminate against American interests.

Nations do not devalue their way to greatness. It's hard to imagine that the U.S. would start manufacturing the toys, TVs, and underwear that it now imports from China. More likely it would just pay more for the same items—or buy them from other low-wage nations such as Mexico, Vietnam, and Indonesia. The last time the yuan rose in value, by 20 percent from 2005 to 2008, the U.S. trade deficit with China actually grew by about the same percentage. World Bank President Robert B. Zoellick, in a Sept. 21 interview with Bloomberg Television, tried to strike a reasonable balance. Zoellick, who served as President George W. Bush's U.S. Trade Representative, said that while it's "important to continue to put pressure" on the Chinese, rebalancing the world economy is also linked to what he delicately called "budget issues"—i.e., federal budget deficits that are financed with savings from China and elsewhere.

Instead of stressing over currency, the U.S. should emphasize improving market access for American companies in China, argues John Frisbie, president of the U.S.-China Business Council. Over the past year, China has stepped up its "indigenous innovation" campaign, which aims to develop the nation's high-tech industries. If it does so through subsidies and discrimination against foreign companies, then it's in clear violation of WTO rules. The United Steelworkers union on Sept. 9 launched a trade complaint against China over subsidies of its clean-energy technology. That's the right approach. Austan Goolsbee, President Barack Obama's new chief economic adviser, told Bloomberg editors at a Sept. 22 lunch that the Obama Administration is determined to "enforce the rules of the road" after a drop in trade actions under the Bush Administration.

Coping with China is never going to be easy, yet lashing out in frustration is a recipe for failure. Beijing plays a disciplined, careful game. So should Washington.

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