The House Ways and Means Committee has just approved a bill that would attempt, albeit modestly, to crack down on Chinese currency manipulation, a key cause of America’s trade deficit. The Ryan-Murphy currency bill (HR 2378) would allow the Commerce Department to treat currency manipulation as an illegal subsidy for the purpose of calculating countervailing duties intended as retaliation. This bill has to be passed by the full House of Representatives and then the Senate before becoming law, but already the prophets of doom are squealing about the dangers of starting a trade war with China. They are wrong.
How does China manipulate its currency? Mainly by preventing its exporters from using the dollars they earn as they wish. Instead, they are required to swap them for domestic currency at China’s central bank, which then “sterilizes” them by spending them on U.S. Treasury securities (and increasingly other, higher-yielding investments) rather than U.S. goods. As a result, the price of dollars is propped up — which means the price of yuan is pushed down — by a demand for dollars which doesn’t involve buying American exports.
The amounts involved are astronomical: China’s accumulated dollar-denominated holdings amount to $2.4 trillion, an astonishing 40 percent of China’s GDP. The China Currency Coalition estimated in 2005 that the yuan was undervalued by 40 percent; past scholarly estimates have ranged from 10 to 75 percent. China has in the past allowed token appreciation of the yuan, but nothing serious. As a result, China is now responsible for 83 percent of America’s non-oil trade deficit.
Doomsayers argue that American retaliatory tariffs on Chinese exports would be met by Chinese tariffs on our own exports, producing a cycle of retaliation that would choke off trade between the two nations. It is an easy disaster scenario to imagine, especially if one believes the utter myth that such a cycle is what happened during the Great Depression due to the Smoot-Hawley tariff of 1930. But this is actually unlikely, for a number of reasons.
For a start, there is the fundamental fact that China is unlikely to engage in catastrophic escalation because they, not we, are running the surplus, so they are the ones with something to lose. (China’s exports to the U.S. are more than four times America’s exports to China.) The only way a deficit nation can “lose” a trade war is by having its trade balance get even worse. Given that the U.S. trade balance is already outlandish, it is hard to see how this could happen.
Of course, China has other cards up its sleeve, like threatening to dump its massive dollar reserves. But doing so would carry enormous costs for Beijing. For a start, beginning to sell these reserves would reduce the value of the large reserves they would still be holding. Furthermore, this would depress the value of the dollar — exactly the opposite of their currency manipulation strategy. Then there is the awkward problem of what China would do with all the money it would get by selling off its dollars. There just aren’t that many good alternatives for parking that much money. The Japanese don’t want their currency used as an international reserve currency (and will stymie anyone who tries), and the euro has huge problems of its own right now. Assets like gold and minor currencies are volatile or in limited supply. Other assets, like American or European real estate or corporate stocks, are, by definition, denominated in dollars or euros, so this wouldn’t get around the currency problem.