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October 23, 2007

And They Have the Nerve to Call This Free

Friedrich von Blowhard writes:

Dear Blowhards,

I saw this little item from October 18 while surfing the web last night; it is Dan Steinbock's "Multinationals Fear US-China trade wars.” (You can read the whole item here.)

The part that caught my attention was:

Some 119 leading multinational companies...including Boeing, Citigroup, General Motors, and Microsoft...have called on Congress to reject protectionist legislation against China, arguing that "imposing unfair barriers to trade in the name of currency valuation or product safety is not a solution to the underlying concerns". It was "a vote for free trade", reported the state-owned China Daily, which, as so many other Chinese observers do, argues that rising protectionism among some US lawmakers "seriously threatens the interests of China, the United States itself and the world at large".

The story goes on to reference Wall Street's, er, I mean, our Treasury Secretary Henry Paulson's view on this issue:

During the past few weeks, US Treasury Secretary Henry Paulson has repeatedly warned Congress against making legislation aimed at punishing China over its economic policies. "When we look at taking unilateral actions aimed at another nation, this can have enormous repercussions to our economic well-being," Paulson said. "You know, we're playing with fire."

Well, if we’re playing with fire, it just might be because we’ve already been burned. I had an especially hard time stomaching the notion that the U.S.-China trade status quo has anything to do with that venerable concept, free trade.

My distaste for the way this buzzword is thrown around in current debates was reinforced by an item I noted on Brad Setser’s blog. Mr. Setser is no mere blowhard, opining on matters well beyond his competency. He actually worked for the US Treasury from 1997 to 2001 on international financial architecture, sovereign debt restructurings, and was the acting director of the US Treasury''s Office of International Monetary and Financial Policy.

In a post from October 23, 2007, he discusses the very different responses we’re seeing from the "developed world" and the "emerging world" to the fall of the U.S. dollar and the consequent rise of other currencies, chiefly the Euro and the Australian dollar. (This revaluation is making exporters from Europe and Australia worried that their exports may get priced out of the market.) From Mr. Setser:

The FT notes, in today’s leader, that the G-7 hasn’t been able to agree on the massive, co-ordinated intervention needed up hold the dollar up against the euro...The funny thing is that the emerging world has been able to muster support for massive, global intervention needed to hold the dollar up...

He explains how the Asian developing countries have managed such unanimity without any formal organization, like the G-7 talks, to promote such cooperation. The chief element of this discipline appears to be fear of China’s export machine, powered in large part by a severely undervalued currency: long as China resists allowing its currency to appreciate--a policy that requires that China buy tons of dollars in the foreign exchange market and invest tons of money in the US--any emerging economy that allows its currency to appreciate against the dollar also allows its currency to appreciate against the RMB. That has a real cost. Ask India. Or Thailand. Those emerging Asian economies that have allowed their currency to appreciate [against the dollar] are seeing a very rapid rise in their imports from China. [As a result, almost] every emerging economy is--or has--intervened over the past year to prevent their currencies from appreciating...China's 2007 intervention in the foreign exchange market--counting funds shifted to the CIC--is likely to be well above 15% of China's GDP.

More than 15% of China’s GDP is going to maintain an artificially weak (and thus export-favorable currency)??!! Golly, that sure sounds like pretty expensive trade to me.

I’ve read a good deal of educated nonsense on this point in pro-globalization journals like the Economist that pretend to doubt that China's currency is seriously undervalued. Another post by Mr. Setser from several days earlier makes a pretty strong case that this is, indeed, the case:

Definitive proof that the RMB is undervalued?

Chinese exports to India grew by 67.5% in the first three quarters of 2007. Bloomberg, last week:

"Exports to the U.S. rose 15.8 percent in the first nine months from a year earlier and those to Europe jumped 30.8 percent. Shipments to India soared 67.5 percent, the customs bureau said. "

It is kind of hard to argue that China will be running a trade surplus with India no matter what, because Chinese wages are so much lower than Indian wages. Or for that matter to argue that India--Indian households at least--run a big deficit because they won't save, no matter what. Louis Kuijs found that Indian households actually save more than Chinese households. (emphasis original)

(You can read all of this post here. You really should because discusses how the Chinese economy is evolving, with serious implications for developed-world trade policy.)

It seems as if our multinational corporations, Wall Street, and the Chinese all have a pretty self-serving definition of free trade. Apparently the term has come to mean any trade or investment flows that are profitable for them.

This is one more example of how the general intellectual toolkit of the standard educated American, who was taught in Econ 101 about the inevitable benefits of free trade, needs a serious upgrade. Unless, of course, they enjoy being lied to or manipulated.


Friedrich von Blowhard

P.S. For those interested, you can read a brief but highly informative overview of the impacts of Chinese currency manipulation here.

posted by Friedrich at October 23, 2007


You sound relatively informed about this issue, and you and I both seem to read the same kinds of sources (big fan of Setser by the way!).

There's no doubt China pays a price for not letting its currency float. But what are the policy implications for the US Congress?

Many seem to feel that we should penalize Chinese products by imposing tariffs on them. But that makes absolutely no sense for either country. also, there's a good chance we'll be publicly ridiculed at WTO if China files a complaint.

Often these so-called punitive measures have a habit of backfiring because it publicizes our own currency's weeakness to the world.

I see no need to slap punitive (and self-destructive) trade sanctions against the Chinese because their currency isn't what we think it should be.

Posted by: Robert Nagle on October 23, 2007 5:53 AM

"imposing unfair barriers to trade in the name of currency valuation or product safety is not a solution to the underlying concerns"

So taking the risk being poisoned is one of those necessary costs of "free trade"? Everything I've heard and read indicates that only a tiny percentage of imported food and other ingestible items are inspected before they reach the consumer.

Posted by: expat on October 23, 2007 6:42 AM

Mr. Nagle:

I'm glad you're paying attention to this issue, which is the undiscussed flip-side of our credit bubble. I wonder a bit at your terminology, however: who cares if we "publicize" the weakness of our currency to the world? I think its a bit late in the day to worry about that: everybody is quite aware of our unsustainably large trade deficit, especially in the context of weakening demand brought on by the housing crisis. The only question is whether we work to bring the dollar down gradually or try to support it and then watch it eventually collapse like the House of Usher.

Also, you act as if a weak currency is a sign of weakness or unmanliness or something. Clearly, the Chinese don't think so: look how hard they are working to keep theirs as weak as they can manage. Wall Street doesn't like a cheapening dollar, but let's face it, they're very, very short term thinkers, and they'll cope.

I'm not an expert in the minutia of the WTO, so I can't give you detailed advice there. But from a larger political point of view, it appears as if the Chinese are essentially gaming the international trade and currency system to the detriment of many, many other countries. As far as I can tell, their strategy of keeping their currency artificially low to gain export advantage is causing problems in Europe, the U.S., Australia, and even the rest of developing Asia. With the possible exception of Japan and Korea, I don't see who isn't threatened by this deliberate distortion of world trade.

It wouldn't seem impossible to gather a broad-based coalition to put pressure on China to give this scam up, or to take action to halt it.

What we don't need to do is keep acting as enablers to China, the way we've been doing since the Clinton administration. Heck, we could actually make a serious effort to encourage internal savings and investment in our own country, and work hard at becoming an export powerhouse ourselves (remember, we manufacture far more than the Chinese do today.)

All that hard work and discipline stuff might not be as much fun as investing in successive asset bubbles. But the alternative (doing more or less nothing) is going to drive us off a cliff, with a very steep collapse of the value of the dollar, a huge and equally abrupt run-up in US interest rates, a lot of international turmoil, further erosion of US blue-collar manufacturing jobs and continuing growth of income inequality as Wall Street tycoons and corporate CEOs pull in all the globalization loot for themselves. (The average Joes, having lost their home equity ATM machine, aren't going to be able to take advantage of cheap Chinese goods much longer.)

That outcome doesn't seem like something we should be patiently waiting for to me.

Posted by: Friedrich von Blowhard on October 23, 2007 7:41 AM

Beginner's question: could someone explain how a country keeps its currency at an artificially low level relative to other currencies? Apparently it takes 15% of China's GDP to manage this feat. What's involved?

Posted by: ricpic on October 23, 2007 8:56 AM


i'm not sure of the details, but it comes down to buying someone elses currency with your own. By buying dollars, in the form of treasuries, they increase the value of the greenback. Japan has done this as well for along time so that we can afford to buy more of their exports.

If you have a positive trade balance; you export more than you import, then it's to a countries advantage to have a weak currency.

I've got a question of my own however. Lots of people complain about negative trade balances, but are they really insustainable? It seems to me you can keep up a negative trade balance as long as it doesn't exceed the amount of original wealth your generating.

Say you produce 10 units of original wealth. You import 5 units of wealth and only export 2 units. Your still up +7 units of wealth and can maintain the imbalance forever, because wealth is not a zero sum game. Or is there something i'm missing?

Posted by: ZetJi on October 23, 2007 4:33 PM

Friedrich, a totally irrelevant point about rhetoric.

I for one am sick of the overuse of the adjective "strong" in political contexts. Apparently you lose the Bubba vote whenever an opponent advocates a position of inflexibility/bloated spending/intervention/putting our dicks in the line of fire.

If the Democrats are going to take control, they need to hire some quarterbacks and sports announcers to "toughen up their language".

"Publicize our own weakness". I initially wanted to give an example, but couldn't think of the name of Malaysia's old Prime Minister. Now I remember Mathathir. In the middle of economic uncertainty, Mathathir launched a tirade against currency traders and blamed George Soros and the international Jewish conspiracy. Investors all around the world took heed; they lost total confidence in Mathathir's ability to run an economy. Mathathir's pronouncements inadvertantly accelerated the fall of Malaysia's currency.

This is not the greatest example to illustrate what I mean (the Malaysia case was an abberation), but when you start blaming outsiders, that is a danger signal.

Posted by: Robert Nagle on October 23, 2007 10:42 PM


Sorry to take so long to get back to you. This is a brief explanation of how China manipulates the value of its currency from the Economic Policy Institute. It was written in 2003:

In recent years China's booming economy, fueled by large inflows of foreign direct investment (FDI) and rapid export growth, has emerged as a significant force in the global economy. This year, China surpassed the United States as the world's largest recipient of FDI, and its bilateral trade surplus with the United States reached $117 billion in the 12 months up through August 2003.

Both inward investment and export growth create strong demand for China's currency, the yuan. All things being equal, such demand pressures should cause the yuan to appreciate relative to the U.S. dollar and cause China's external position to return to balance.

But all things are not equal: China pegs the yuan to the dollar at a fixed rate and strictly regulates imports and the allocation of foreign exchange. In order to maintain the yuan's fixed value, China must create a residual supply of yuan to counter growing demand for its currency; China achieves this by buying dollars in foreign exchange markets. Between December 2000 and July 2003, China more than doubled its foreign reserve holdings from $168 billion (16% of its GDP) to $361 billion (31% of its GDP).

Posted by: Friedrich von Blowhard on October 24, 2007 5:54 PM

Yep, RMB undervalued. Nope, not in US best interests, or at least that is most certainly not why China is doing it. I attended a seminar recently taught by a Chinese national who has now worked in US for over 15 years. As a result, I both fear them more and less than I did. Never, ever kid yourself---China is not interested in global "cooperation" or "everybody-wins"---they are first, last and in-between interested in China winning. Which is OK, but best to not be forgotten. But China is actually a bit of a mess, which makes them less ominous, but still scary because they are a great big giant worid-market-moving mess. Over 30% of their banks assets are in non-performing loans, because they don't really know how to make loans, given that their only charge under Commie China was to sustain full employment. They don't really know how to control production levels, which means they periodically over-shoot and therefore flood world markets with their mounting inventory---see world steel markets in 2006. Then they pull back again when they've caught up with their own train, making volatile swings in commodities always possible. They are corrupt--bribing and flirting are necessary skills in even beginning to figure out how to get anything done there. They have a very under-developed stock market, and credit cards for individuals are in their infancy. Which means lots of pitfalls to come.

And, yes, our fearless Treasury secretary is their stooge, indirectly, because he is Citibank's stooge and Citi has a jump on other financial providers in that it has a bigger presence there than any other US financial company---however, it is still dwarfed by the state-owned banks in China.

Posted by: annette on October 25, 2007 12:04 AM


Stooge is such a great word, isn't it?

Especially for Paulson.

Posted by: Friedrich von Blowhard on October 25, 2007 1:42 AM

Before getting all excited about a 67% increase in Chinese exports to India, find out what the absolute amount is. If the increase was from $10M to $16.7M... that's not a big deal.

My guess is that the increase reflects the increased buying power of India's middle and upper classes, and of India's businesses. They are buying more of the manufactures that China has mastered producing cheaply and in huge volume. Power tools, appliances, cheap electronics, office equipment... production of these goods is migrating to India, driven by the wage differential, but India lags in building the factories and infrastructure. China had the leadership of Hong Kong and even Taiwan as cadre.

I wouldn't be surprised to find that a lot of Chinese exports to India are de facto capital goods - tools, for instance.

Posted by: Rich Rostrom on October 29, 2007 5:40 AM

Mr. Rostrom:

And this momentous discovery that China makes superior items that the Indian middle classes crave only happened the very same time the Chinese currency, effectively pegged to the dollar, is depreciating against the unpegged Indian currency? Kind of an odd coincidence that the Indians would wise up just when the Chinese goods are getting dramatically cheaper, isn't it?

Sorry, but the timing is strongly against your argument.

Posted by: Friedrich von Blowhard on October 30, 2007 12:01 PM

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