China vs. the United States Congress

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Government won’t cite China on currency:

The Bush administration on Wednesday declined to cite China for manipulating its currency to gain unfair trade advantages and declined lawmakers’ request to pursue a trade case on the issue.

The administration’s actions provoked an outcry from members of Congress. They said soaring U.S. trade deficits with China had cost thousands of U.S. manufacturing jobs and merited a tougher response against the Chinese for their trade practices.

Bear in mind the things that provoke an outcry from the US Congress. Funnily, comparing two stories in the Washington Post and the Guardian, it was the Guardian that mentioned the backing new legislation being planned had from trade groups.

To the credit of US Treasury Secretary Paulson he doesn’t seem to have responded in any form of encouraging fashion to the protectionist thrall in which the US government is held (clear back, I would remind you, to the populism of Kerry and Edwards in 2004). But he is correct that something ought to be done. The yuan has moved very little since being disconnected from the US dollar a couple of years ago (students: we call this a dirty float, when the currency is floated but managed - more or less heavily, depending - by the domestic central bank).

It’s a bit tricky. China’s trade surpluse is phenomenal, and we all remember last year’s news that China’s foreign currency reserves had hit USD1tr in value (increasing around USD18bn per month, to boot). What to do with all of that?

The low value of the yuan keeps exports high. That’s a hell of a lot of wealth flowing into China, and it can’t handle the sort of domestic investment it’s experiencing for ever. The huge pile of money from buying up foreign securities doesn’t help at all.

To ditch it is risky, for a couple of reasons: first, China holds something like USD500-700bn in US government securities - i.e. dollars. If China sells them, or even looks like selling them, they go down in value. This means that the value of this wealth, for China, deteriorates even as it tries to realise it, but it also has a big impact on the US, sending down its dollar and, alley-oop, the yield on those government securities.

The government needs that borrowing, pretty badly as days go buy, and it will have to raise interest rates to keep getting it, if the dollar is declining on the ForEx market. I’ve mentioned this about 50 times now, and I apologise, but that’s the wrong sort of pressure to have on interest rates, particularly if the US is facing recessionary indicators. The Fed needs the freedom to move interest rates to benefit the domestic economy, not have them locked in by the budget deficit.

Although I poo-pooed the 1.4% increase in spending as low in the OECD, it’s still a lot higher than predicted, and also increases the likelihood of a rate rise. Inflation in the US is running around 3%.

China also doesn’t get much from domestic consumption, but from exports and investments - hence the tight control over its currency - but this means that it has less control of domestic inflation, as well. Currently that’s 3.4%, vs. the usual 3% target. This isn’t unique, in fact inflation is popping up all over - leading to a fair bit of selling of US securities, and falling yields (the US selling a bunch of them to raise money didn’t help). But it might come as good news to Sec. Paulson, since it makes up external pressure on China to slow down the cash coming into their overheating economy. He might just catch a break.

I’ll talk about the ‘bad’ of trade protectionism some other time. I have to go stitch together a paper for a colleague.

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