Risky Business

On Wednesday, the House of Representatives passed one of the last significant measures likely to be debated in the 111th Congress, a bill threatening to slap tariffs on Chinese-made goods unless China allows its currency to rise in value. The bill's prospects in the Senate are unclear, but it has its advocates, including New York's Chuck Schumer who complained Tuesday that the Obama administration's approach to the issue is nothing but "more talking … despite the fact that years of meetings and discussions with Chinese officials in an effort to persuade China to float its currency have repeatedly failed to produce lasting, meaningful results."

As a political gesture, this is pretty good. The public wants to see action on unemployment. But job-creating "stimulus" has become unpopular, so a nice piece of legislation blaming foreigners for our problems makes a lot of sense. Even better, the currency-value issue is a real problem. Unfortunately, Congress' proposed solution is risky and unlikely to work. The good news is that there is a better way. It doesn't take a nation of billions to drive the value of the dollar down; we can and should do it ourselves.

But first, what's the issue here?

The issue is trade. Over the past 30 years, China has liberalized its economy substantially relative to the Mao-era baseline. That has vastly increased China's productive capacity -- up 7 percent to 10 percent per year each year. When Americans buy products that are produced in whole or in part in China, dollars are sent to China where they're exchanged for Chinese currency, the renminbi, which is used to pay Chinese people. And when Chinese people buy stuff from America, they first need to buy dollars with which to pay us. For years, the tendency has been for Americans to buy more stuff from China than China buys from America. That means that on net dollars are being exchanged for renminbi.

What normally happens in a situation like that is the price of renminbi goes up relative to the price of dollars. That makes Chinese-made goods more expensive in America and American-made goods cheaper in China. Consequently, Americans buy less Chinese-made stuff, and Chinese people buy more U.S.-made stuff, and the trade flows balance out.

But China, for a whole bunch of reasons, doesn't want to let its currency "float" on a free market. That means that to prevent the renminbi from getting too expensive, the country's central bank, the People's Bank of China, periodically buys up a bunch of American financial assets in order to keep the renminbi cheap.

This ends badly for American manufacturers. If the renminbi were more expensive, Chinese people would have more purchasing power and would buy more American-made stuff.

On the other hand, the portrayal of this as a situation in which China is "cheating" in the global trade game and stealing our jobs is both simplistic and inaccurate. Suppose the United States imposed a nationwide sales tax and then subsidized manufacturing companies with the revenues. People would see that as a regressive transfer to a narrow interest group and would wonder how our political system got so screwed up. Well, China's political system is not exactly the envy of the world. And keeping its money cheap is in effect a way of taxing the earnings of ordinary Chinese people in order to subsidize politically influential exporters. That doesn't mean Schumer's wrong that the cheap renminbi is bad for America, but it sets up a context that's more about mutual problems than assigning blame.

The problem with the bill in Congress is that the proposed solution misses the mark. Threatening to slap high taxes on Chinese-made goods could cause the Chinese government to change its approach. By the same token, threatening to shoot a nuclear missile at Beijing could also produce such an effect. Or it might lead to a downward spiral of retaliation and recrimination that only makes things worse. At the end of the day, putting higher taxes on Chinese-made goods is only going to make things worse for American consumers and Chinese workers alike. The proposition that it will help U.S. manufacturers is based on the dubious notion that U.S.-China trade is mostly in identical goods. Realistically, the main consequences of a trade war would be Americans purchasing more stuff from countries that are similar to China (Vietnam, Bangladesh) while China buys more from Canada, Europe, and Japan.

The good news is that there's a better way. The spectacle of the world's only superpower puzzling over the best way to reduce the value of our own currency is slightly bizarre. To be crude about it, you make dollars less valuable by having the Federal Reserve print more dollars, not by complaining to China. In technical terms, there are a number of ways you could achieve this. One is what's known as unsterilized foreign-exchange interventions. Another is Joe Gagnon's idea for bond purchases. The Fed can even print money and buy people's old socks with it. The point is that more dollars equals less valuable dollars. The result would be modest inflation in the United States -- which as Paul Krugman explains would be a good thing on its own terms. Then the only way for China to prop up the dollar would be to create ruinous inflation in its own country, which there would be no good reason to do. Problem solved.

To get the results, Congress needs to focus attention on where the real problem is -- the Federal Reserve -- which has been too hesitant to act and whose board continues to face three vacancies thanks to the Senate's refusal to confirm Barack Obama's nominees. Admittedly, this doesn't pack the political punch of scapegoating foreigners. Unlike the tariff threat, though, it's overwhelmingly likely to work. And at the end of the day, voters will reward results.

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