China\u00e2\u20ac\u2122s President Hu Jintao will visit Washington DC next week (April 20) where he will meet with President Bush. For the last several years, China\u00e2\u20ac\u2122s under-valued exchange rate has been imposing large costly distortions on the American economy. Unfortunately, the Bush administration has taken no action. Instead, it has allied itself with multi-national corporations who are profiting handsomely from the current U.S. \u00e2\u20ac\u201c China economic relationship, which allows them to import cheap Chinese products on which they earn huge margins. If the President won\u00e2\u20ac\u2122t take decisive action to get China to significantly revalue its exchange rate, Congress should. Here is an economic indictment against China that justifies such action.<\/p>\n
The principal focus of attention has been the trade deficit with China. Over the past four years the China deficit has risen from $83 billion in 2001 to $202 billion in 2005, and it has been growing much faster than the deficit with the rest of the world. Moreover, China\u00e2\u20ac\u2122s impact is widely believed to extend beyond this direct effect. This is because many East Asian countries hold down their exchange rates for fear of losing competitiveness relative to China, thereby raising their trade surpluses with the United States.<\/p>\n
The trade deficit has had several damaging effects. The first has been the destruction of manufacturing jobs, with many companies closing U.S. plants because they cannot compete. Some companies have simply gone out of business, while others have re-located or sub-contracted production to China. Additionally, companies have re-directed new investment to China rather than building new modern capacity in the United States. This has structurally weakened the U.S. industrial base.<\/p>\n
The trade deficit also helps explain why this economic recovery has been the weakest since World War II. Instead of creating jobs at home, consumer spending has leached out of the economy in the form of spending on imports. In the past, consumer spending would have created hundreds of thousands of domestic manufacturing jobs. This time round it has created them in China.<\/p>\n
Washington\u00e2\u20ac\u2122s free trade lobby has trumpeted how consumers have enjoyed low prices. This is true. The sting that they have omitted is that consumers are also now loaded with debt and we have not created the jobs and investments that generate future income to repay those debts. This spells economic trouble down the road.<\/p>\n
Another distortion concerns financial markets. For much of last year Federal Reserve officials wondered why long-term U.S. interest rates were not rising despite the Fed raising short-term interest rates. The reason is that China (and other East Asian countries too) has been buying U.S. bonds with its trade surplus. These purchases have held interest rates down and kept China\u00e2\u20ac\u2122s currency under-valued.<\/p>\n
This distortion of financial markets has had serious consequences. First, in the past when the economy strengthened, long-term interest rates rose automatically and provided an automatic stabilizing mechanism. This time round that mechanism has been absent.<\/p>\n
Second, China\u00e2\u20ac\u2122s creation of artificially low interest rates has contributed to America\u00e2\u20ac\u2122s house price inflation. By keeping interest rates down, China has artificially kept mortgage rates down and thereby contributed to a possible U.S. house price bubble. If there is a bubble, when it goes flat millions of households will find that they have over-paid for their homes and will be left holding large losses. These losses stand to be far larger than any conceivable consumer price savings from cheap Chinese products, and the debts incurred will also act as a drag on future economic activity and employment.<\/p>\n
A third related impact from China\u00e2\u20ac\u2122s distorting effect on financial markets concerns the pattern of investment. Lower interest rates are a positive factor for investment, bur China\u00e2\u20ac\u2122s under-valued currency discourages investment in manufacturing. Consequently, the pattern of investment has been twisted, with under-investment in the traded goods sector (manufacturing) and possible over-investment in the non-traded sector (services and construction). This risks a repeat of the 1990s new economy where much investment in start-up firms turned out to be wasteful.<\/p>\n
A final way in which China\u00e2\u20ac\u2122s under-valued currency has impacted the U.S. economy is through China\u00e2\u20ac\u2122s impact on Mexico. For the past several years the business press has been full of stories of manufacturing firms leaving Mexico and going to China where wages and labor standards are even lower and the exchange rate is under-valued. The closure of Mexican factories and the loss of Mexican manufacturing jobs have in turn increased illegal immigration into the United States. This has increased the labor supply, and contributed to additional downward wage pressures at the low skill end of the labor market.<\/p>\n
In a global economy, economic dislocations within countries have ramifications far beyond the countries directly affected. China\u00e2\u20ac\u2122s under-valued currency and unfair trading practices policies have been causing problems for the entire developing world by sucking jobs and foreign investment away from these countries. With regard to Mexico, these problems have imposed significant additional knock-on costs on the United States.<\/p>\n
Free trade economists like to talk of China having a comparative advantage in manufacturing, and they use that talk to justify China\u00e2\u20ac\u2122s trade surplus. This talk is bogus. The theory of comparative advantage assumes countries have overall balanced trade. The U.S. has a massive trade deficit. According to China\u00e2\u20ac\u2122s own statistical agency, China has a massive global trade surplus and data for 2005 data shows it continues to increase. Additionally, there is robust evidence that China\u00e2\u20ac\u2122s official statistics are under-stated. This speaks to the distorted pattern of China\u00e2\u20ac\u2122s trade. China is not trading on the basis of comparative advantage, but on the basis of an artificially under-valued exchange rate and mercantilist commercial policies that subsidize exports and restrict imports.<\/p>\n
In a market economy, distortions in one market spillover and cause distortions in other markets. The U.S. is a market economy, and China has distorted the pattern of international trade and U.S. financial markets. Exchange rates and interest rates are perhaps the two most important prices in the U.S. economy, and China has been distorting both. These distortions have generated huge costly misallocations of resources within the U.S. economy that will have lasting consequences, and China\u00e2\u20ac\u2122s policies have also injured developing countries. Case closed!<\/p>\n","protected":false},"excerpt":{"rendered":"
China\u00e2\u20ac\u2122s President Hu Jintao will visit Washington DC next week (April 20) where he will meet with President Bush. For the last several years, China\u00e2\u20ac\u2122s under-valued exchange rate has been imposing large costly distortions on the American economy. Unfortunately, the Bush administration has taken no action. Instead, it has allied itself with multi-national corporations who […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[3],"tags":[],"class_list":["post-44","post","type-post","status-publish","format-standard","hentry","category-us-policy"],"_links":{"self":[{"href":"https:\/\/thomaspalley.com\/index.php?rest_route=\/wp\/v2\/posts\/44","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/thomaspalley.com\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/thomaspalley.com\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/thomaspalley.com\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/thomaspalley.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=44"}],"version-history":[{"count":2,"href":"https:\/\/thomaspalley.com\/index.php?rest_route=\/wp\/v2\/posts\/44\/revisions"}],"predecessor-version":[{"id":1671,"href":"https:\/\/thomaspalley.com\/index.php?rest_route=\/wp\/v2\/posts\/44\/revisions\/1671"}],"wp:attachment":[{"href":"https:\/\/thomaspalley.com\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=44"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/thomaspalley.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=44"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/thomaspalley.com\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=44"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}