U.S. Wants Change in Currency Policy, but Benefits Aren't Clear-Cut
By Paul Blustein
Washington Post Staff Writer
Wednesday, May 11, 2005
William Zeus's anger is palpable as he recounts how cheap Chinese imports have forced his company, National Tool and Manufacturing Co., to close two plants and lay off abou t 55 workers in the past couple of years. The problem, according to Zeus, is that China enjoys an unfair advantage in world markets: the artificially low exchange rate of its currency, the yuan.
"There's not a lot to it except arithmetic," said Zeus, whose Kenilworth, N.J., firm makes sophisticated tools and components for makers of molds used in manufacturing. "In our industry the Chinese are often 30 percent, and sometimes 50 percent, cheaper than products made in the United States. A lot of that has to do with the fact that the yuan is undervalued, which means that goods imported from China are cheap."
A clamor of similar complaints from America's industrial heartland is galvanizing official Washington into action. Whether such action will benefit manufacturers like Zeus, however, is a matter of considerable debate.
At issue is China's policy, which it has maintained since 1995, of keeping the yuan pegged at 8.28 yuan per dollar. That value for the yuan, Beijing's critics assert, is substantially lower -- by 15 to 25 percent, or perhaps more -- than the rate that would prevail if China allowed the yuan to rise and fall with supply and demand as most other major currencies do. The result, they say, is a sharpening of China's competitive edge that has been a major factor behind the explosive rise in the U.S. trade deficit. China accounted for one-quarter of the record $651.73 billion trade gap in goods in 2004, and in the first two months of this year, the U.S. deficit with Beijing surged to $29 billion, up about 50 percent from the same period a year earlier.
Members of Congress from both parties have responded by introducing legislation that would slap across-the-board duties on Chinese imports unless Beijing lets the yuan move significantly. Despite objections that such duties would violate international trade rules, the bill drew support from 67 senators on a procedural vote last month, surprising even its backers.
"We kept hearing from one business after another that the problem we have with China is all-encompassing, but one major problem is the value of their currency," said Sen. Lindsey O. Graham (R-S.C.), who sponsored the bill with Sen. Charles E. Schumer (D-N.Y.).
Thanks in part to the groundswell on Capitol Hill, the Bush administration is also stepping up pressure on China. Until recently, the administration was taking a patient stance in the hopes that China would act on its own. But in the past couple of weeks, top U.S. officials have adopted a tougher tone. A fresh statement of the administration's new line came last week at the Asian Development Bank's annual meeting, where Bobby J. Pittman, the chief U.S. representative, declared that China "should move to a more flexible regime now."
Moreover, the Treasury Department is planning to release a report soon on the foreign exchange policies of other nations, which is almost certain to take a more critical position toward China's practices than past years' reports. Manufacturing industry groups are urging the Treasury to formally brand China a "manipulator" of its currency, which would require the department to initiate negotiations with Beijing. For their part, Chinese officials have hinted that they may alter their policy at any time but will probably do so in a series of modest steps.
Some economists caution that a change in China's currency regime could boomerang on Washington. That is because under its fixed-rate system, China's central bank constantly buys billions of dollars on currency markets, which are invested in U.S. Treasury bonds and provide a major source of financing for the federal budget deficit. If the flow of money from China into the dollar and Treasury bonds were to dry up, financial turbulence might well ensue, including a sharp upward spike in interest rates.
Questioning whether U.S. officials may ultimately regret prodding Beijing for a rising yuan, Nouriel Roubini, a professor at New York University, wrote on his Web log last month, "The first rule of good manners -- and finance as well -- is that you should not bite the hand that feeds you."
Administration officials have studied the likely financial impact of a Chinese currency adjustment and view the problem as easily manageable. Many independent analysts agree, saying that unless Beijing lets its currency float completely freely -- an almost inconceivable step -- it would have to continue buying large amounts of dollars.
But a more fundamental question is whether a stronger yuan will make much difference to the U.S. economy.
Typically, Chinese exports -- such as DVD players, clothing and auto parts -- contain many components and raw materials that come from other countries; the value added in China often involves low-cost assembly and other labor-intensive work. In testimony at a congressional hearing last month, Douglas J. Holtz-Eakin, director of the nonpartisan Congressional Budget Offices, cited research indicating that China contributes only about 20 to 30 percent of the value of the average product that it ships abroad.
Thus, Holtz-Eakin said, even though a rise in the yuan would increase the price of Chinese imports, "those increases would probably be much less than the appreciation of the yuan itself." For example, if the yuan rose 20 percent -- a significant appreciation -- the increase in the price of Chinese imports would probably average only about 4 to 6 percent, Holtz-Eakin said.
Among the companies with the greatest grounds for grievance are U.S. makers of furniture and metal products, said Franklin J. Vargo, vice president for international economic affairs at the National Association of Manufacturers. Their Chinese competitors make most of their product in China.
Even if Chinese imports do rise in price and the United States buys fewer of them, that will not necessarily help shrink the U.S. trade deficit or save U.S. jobs, because imports from other countries may simply fill the gap left by China.
Consider the computer and electronics industry: Imports of computers and other electronics from China have soared in the past several years, with the Chinese share of the market rising from 4.3 percent in 2000 to 11.1 percent in 2004. But as Holtz-Eakin noted in his testimony, imports' overall share of the market stayed roughly the same. The obvious implication, he said: "Imports from China were largely replacing imports from other sources."
Still, the momentum in Washington is clearly in favor of turning the screws on Beijing over the currency issue. The administration's change in tactics is especially striking.
A year ago, when controversy over the issue was starting to erupt during the presidential campaign, the White House rejected calls from Congress and industry groups for threats to be leveled against China's pegged yuan. "The most effective way at this time to achieve the goal of a flexible, market-based exchange rate in China is to maintain the persistent engagement we have established," Treasury Secretary John W. Snow said at a news conference then.
Asked what has prompted the recent hardening in their position, senior administration officials observe that circumstances have changed. For one thing, China's overall trade in goods and services was in deficit in the first quarter of last year, but the nation finished up the year with a trade surplus of $32 billion, and in the first quarter of this year its surplus was about $16.6 billion.
Moreover -- though administration officials are loath to discuss it publicly -- Bush's chief trade initiative this year, the Central Amer ican Free Trade Agreement, is in trouble on Capitol Hill, and by proving its mettle on China the White House stands a better chance of attracting pro-CAFTA votes from reluctant Republican lawmakers.
Whatever eventually prompts China to lift the value the yuan, such a measure could prove a critical first step toward curbing the trade deficit, according to many economists, because it could lead to a rise in the currencies of other Asian countries that also ship massive amounts of goods across the Pacific.
"If China revalues by itself, it wouldn't help the U.S. [trade] deficit very much," said Morris Goldstein, a scholar at the Institute for International Economics. "What you're trying to do is move not just the Chinese, but get a very broad depreciation of the dollar." Goldstein calculates that if the currencies of Japan, China, Korea, Malaysia and other Asian nations rise about 20 percent against the dollar, the broadest measure of the trade gap would decline by about $70 billion to $80 billion.
But those who are badgering Beijing "make it tough for China to reform its system," said Albert Keidel, senior associate at the Carnegie Endowment for International Peace, who until late last year was one of the Treasury's top Asia hands. Feverish speculation that the yuan will soon be worth more is prompting investors to pour as much money as they can into China, in the hopes that they will be holding yuan when the currency rises.
"If China were to introduce some small change in its system, people would say, 'Aha, the currency is no longer fixed,' and they would put more money in," Keidel said. "And if the Chinese moved [the yuan] a lot, people would say, 'Aha, now it's time to get out -- and they'd all get out. So all this jawboning delays the day" when meaningful reform can take place.