By Arthur Kroeber
Sunday, June 17, 2007

You know how people like to quote old Chinese proverbs when they want to impart some wisdom? Well, here's a plain old American saying for Congress as it makes noises about forcing China to push up the value of its currency: Be careful what you wish for.

With China's trade surplus exploding ($232 billion last year) and the United States bleeding industrial jobs (3 million over the past 10 years), some senators on Capitol Hill are pointing fingers at the undervalued yuan, which makes Chinese goods unfairly cheap, as the culprit behind those two developments. The solution, they say, is obvious: Beijing has to raise the value of the yuan -- right away and by a lot -- or face tough trade sanctions.

But if they really thought through what a more valuable Chinese currency would mean, they might not be so keen to demand it.

Let's say the senators get their way and China raises the value of the yuan by 30 percent tomorrow. What happens next? One thing that won't happen is a significant reduction in the U.S. trade deficit. If Chinese exports become too expensive, manufacturers will shift production to cheaper locations in Asia, such as Vietnam. For the same reason, a Chinese revaluation won't restore jobs to the U.S. manufacturing sector. China may lose jobs, but the gainers will be other Asian countries.

On top of that, a sudden revaluation could lead to unintended consequences that might not sit so well with the American public. Here are three possibilities.

Unintended Consequence 1: Home mortgage payments go up.

Americans wouldn't like that, would we? But one side effect of China's trade surplus is that it reinvests a big chunk of its export earnings in U.S. Treasury bonds; it owns more than $1 trillion of them. These purchases help keep interest rates low, both on bonds and on home mortgages, whose rates are linked to those on long-term bonds. If China starts to lose export orders, it will buy fewer Treasury bonds. It might also put more of its reserves in other currencies, as a tit for tat for having been forced to raise its currency against its will. Either way, the likely effect would be an increase in U.S. interest rates.

Unintended consequence 2: The price of gasoline goes even higher.

If China's currency rises, its purchasing power grows, which means that it will import more. But what will it import? It would be nice if it brought in more consumer goods, but this is unlikely. Chinese households are thrifty, and most of what they want to buy is made in China. My guess? The Chinese will start driving more. Public transportation in most Chinese cities is terrible, and car sales are growing by 25 percent a year. A higher yuan would mean lower pump prices, so it makes sense that people would buy more cars and log more miles.

Chinese companies might also respond to a revaluation by moving out of light industries and into heavier, capital-intensive industries such as chemicals, which are energy hogs. (They're already doing this, but a strong yuan would accelerate the process.) All in all, a suddenly stronger yuan could cause a spike in Chinese oil demand, driving world oil prices higher -- as if they weren't high enough.

Unintended consequence 3: China starts to buy up the United States.

Seriously. Are we ready for this? It could be the most important consequence of a big yuan revaluation, and yet nobody's paying much attention. If the yuan rises by 30 percent against the dollar, then from the Chinese standpoint, the price of everything in the United States -- real estate, companies, ports, oil refineries, toll roads -- suddenly costs 30 percent less. It would be perfectly reasonable for Chinese companies, and maybe even the government, to scoop up some of these bargains.

Maybe it's not such a problem economically. Chinese buyers, flush with cash but relative know-nothings in the U.S. market, will almost certainly pay too much for assets that suddenly look inexpensive. Sellers in mature or declining industries could take their gains and invest in newer industries that add to U.S. productivity and wealth. On the whole, the United States would probably come out ahead.

But the public and Congress might cringe at the thought of U.S. companies being snapped up by Chinese firms -- or worse, by government-controlled investment groups. In 2005, Chinese oil company CNOOC tried to buy the U.S. energy company Unocal, and many members of Congress howled with outrage, even though most of Unocal's oil fields were in other countries and the company supplied only a tiny percentage of the oil used by Americans. Just two weeks ago, a fund controlled by the Chinese government spent $3 billion on a 10 percent stake in the Blackstone Group, a big private equity firm. Again, the outcry was full-throated.

These are just two deals. But a big yuan appreciation would unleash many more. That's precisely what happened the last time the United States compelled a major trading partner to revalue its currency. In the 1980s, Japan was accused of competing unfairly in world markets with an undervalued currency. Under the 1985 Plaza Accord, the central banks of the big economies, including Japan, conspired to drive up the value of the yen. It doubled in less than three years, and Japanese firms went on a shopping spree, acquiring such American icons as Rockefeller Center, MGM Studios and even a slice of Goldman Sachs (which sold a 10 percent stake to Sumitomo bank in 1986).

If Chinese firms started to do the same thing, Congress could respond by slapping controls on foreign investment in the United States. (It threatened to do just that in the late '80s, but fortunately the Japanese economy tanked before any controls could take effect.) If these restrictions were too narrowly targeted at Chinese investment, it would be blatant hypocrisy. After all, Washington has spent the past quarter-century lecturing Beijing on the virtues of open markets and free flows of capital. But if the controls were applied more broadly, they would damage our own economy, which relies heavily on foreign investment.

Let's face it. Neither forcing the Chinese to revalue the yuan nor blocking Chinese investment in the United States would do anything to improve the competitiveness of U.S. firms or raise our standard of living. Blame-the-foreigner tactics like that only distract us from the real tasks of seeing to it that U.S. companies keep their innovative edge and that the benefits of economic prosperity are broadly shared.

Over the past two decades, America has done a good job at the first and a poor one at the second. Let's focus on fixing that, not trying to fix the price of another country's currency.

arthur.kroeber@dragonomics.net

Arthur Kroeber is managing director of Dragonomics, an economic research firm with offices in Hong Kong and Beijing.