No Progress On China Currency; What Is To Be Done?

The Chinese government continues to stall for time and push its luck. This behavior risks China's own continued economic growth and risks possible trade actions from the U.S. Congress.

During the third week of May, another round of the bilateral "Strategic Economic Dialog" (SED) betweenthe governments of the People's Republic of China and the United States was held in Washington. The SED is the brainchild of Treasury Secretary Henry Paulson, who believes that getting as many Chinese ministries as possible into dialog with their U.S. counterparts might just solve some trade problems. It also would give him a larger stage on which to discuss the Chinese currency policy, without causing the Chinese to lose face.

Unfortunately, despite all the publicity and high hopes that went into the SED, little of substance was accomplished other than the limited opening of financial markets in China to foreign investment — and agreement that there would be another round of the SED within six months.

With regard to China's artificially weak currency, if anything the situation has deteriorated. Since China allowed a managed float for the RMB in June 2005, its currency has nominally appreciated in value 6.6 percent. But when that figure is adjusted for inflation, the value of China's currency actually has fallen between 2 percent and 11 percent. During that period, to hold the RMB in check, the Chinese have doubled their spending in currency markets —reaching $15 billion to $20 billion per month. So much for gentle persuasion and the irrefutable logic of international finance.

Because China is not allowing its currency to adjust against the dollar, other Asian countries have been unwilling to allow their currencies to increase in value either, in order not to lose their competitive advantage.

Meanwhile, the international economic balance sheet for the United States continues to deteriorate. We now must borrow $8 billion per day in capital from the rest of the world to finance our deficit. Our global current account deficit rose to $857 billion in 2006, 6.5 percent of our GDP, twice the record set in the mid-1980s and the largest deficit ever by a single country. China accounts for one-quarter of that deficit, and we simply have to bring the situation under control or there is a serious risk of international economic collapse should the markets decide that our imbalance is unsustainable.

One plausible explanation why the Chinese were unwilling to accommodate the U.S. government at the recent SED is that the Communist Party Congress, where the Chinese government picks new leaders every five years, will be convened in the fall. Thus, at the May SED it would have been dangerous for trade or finance ministers to make concessions to the United States, because such a concession could lead to replacement of the current minister if he or she looked weak or uncertain. Those ministers were thinking of their careers rather than bold new national policy.

Meanwhile, in the wake of a $233 billion bilateral trade deficit, the U.S. Congress is growing increasingly impatient. With the failure of the SED and other bilateral efforts to effect change, and the unwillingness of the Treasury Department to declare China a "currency manipulator" in their semi-annual report to Congress, it is probable that we are about to enter a more confrontational phase of our relationship with China.

Within the next year, we could see Congress passing some variation of last year's bipartisan Graham-Schumer proposal for a 27.5 percent tariff on Chinese goods. The votes were there last year, but Secretary Paulson begged for more time for quiet diplomacy. As with President Bush's "surge" in the war in Iraq, it is hard to point to successes in our trade and currency negotiations with the Chinese.

A popular president, with his party strongly behind him and in control of the Congress, might be able to defuse the pressures to take precipitous trade action against China. I doubt that this president has the ability to resist that action. We are entering a volatile and perilous time in our bilateral relationship.