About That Currency Bill and the 'New Normal'

By now, a number of people have weighed in on the resounding passage (348-79) of the House of Representative bill that would allow the U.S. to levy tariffs on Chinese exports due to its undervalued currency (see here, here, and here, for example). At the risk of being redundant, I'll jump in with a few thoughts, since this is one of those issues that cannot be ignored if you're commenting on China.

The fact that 99 Republicans voted for the bill obviously allows the House to claim "bipartisanship" and telegraph to the Chinese that Congress has run out of patience, even if the White House remains reticent. And if you saw the House debate before the vote, there was clearly a lot of chest-thumping about the direct correlation between Chinese distortionary currency policies and the lack of American jobs. (The Congressman from Flint, Michigan blamed the plight of the once industrial town entirely on China.) Most economists do not think this argument holds much water, and, in fact, there is no consensus on by how much the Chinese currency, the renminbi, is actually undervalued...is it 20 percent or 75 percent? Frankly, no one knows. And besides, China is not the only country that "manipulates" its currency. Its powerful neighbor and U.S. ally Japan recently also intervened in its currency, the yen, to prevent it from appreciating against the U.S. dollar. Since this bill technically applies to all countries, then currency policies in a country like Japan would also be called into question.

Yet despite passage of this bill in the House, it is unlikely to be picked up by the Senate. As my colleague Sean West, who follows the U.S. Congress much closer than I do, smartly writes:

First, Senator Charles Schumer (D-NY) still prefers his own legislation to that passed by the House. This means that not only would the Senate have to approve his more comprehensive version but then the two bills would have to be reconciled by a conference committee and the resulting version passed through both chambers again. There is almost certainly insufficient time for this.

Second, the White House did not formally endorse the bill upon passage: Treasury simply noted that the vote showed "lawmakers have serious concerns about this issue," and that the President and Geithner "share those concerns." The President may well be unprepared to veto the bill but the administration is not putting its muscle behind passage.

Third, there has been no indication from congressional leadership that a China currency bill will be a lame duck priority. Beyond an all-encompassing battle over the fate of the Bush tax cuts, Democrats are considering 20 separate bills for the lame duck period. Timing is the chief challenge to passage this year.

BUT, getting past the midterm election cycle may not be the end of it. West continues:

However, 99 Republicans, led by the next probable House Ways and Means Committee Chairman David Camp (R-MI) voted for it; Camp even said he thought it was WTO-compliant. Splits in the Republican caucus on the issue will complicate efforts by Republicans to hold back simmering congressional discontent next year in the baseline scenario that Chinese appreciation remains very slow.

A separate trigger for action against China next year may be that it is the price the White House and free trade agreement (FTA) supporters will be asked to pay for championing pending trade deals with South Korea, Panama, and Colombia. Obama is looking to announce a side deal on the US-Korea Free Trade Agreement (KORUS) at the Seoul G20 in November...

Given all this, however, both U.S. and China are trying to pilot the relationship to a less turbulent and manageable altitude. The Chinese response has been considerably calm and reasoned so far, compared to the jingoistic rant that it can often morph into. The official Xinhua comments:

The congressmen should take note that the China-U.S. trade imbalance is the outcome of incremental international division of labor.

In the past three decades of free trade and international competition, U.S. competitive advantage has passed from manufacturing industry to the service sector with higher added value. Reducing imports from China can not heal the condition of U.S. manufacturing incompetence against the world.

A 20-percent appreciation of the yuan along with a similar currency appreciation by other emerging Asian economic entities may contribute at most 1 percent of the U.S. gross domestic product growth, said Olivier Blanchard, chief economist of the International Monetary Fund (IMF).

The congressmen should understand that what is behind the huge U.S. trade deficit is perpetual expansionary fiscal and monetary policies, high debt ratio, low residential deposit ratio, credit deficit and trade barriers for hi-tech exports.

They should also know that U.S. companies and consumers benefit from Chinese low-price commodities. A sharp appreciation of the yuan equals to a sharp rising prices of Chinese products, which are not helpful to the U.S. economy.

This brings me to a larger point about the U.S.-China economic relationship. Ever since the financial crisis, the Chinese have become increasingly more willing to take U.S. policies to task, and often enlist western economists to make their arguments ("see, if you don't believe us, your IMF economists are making the same case..."). It's certainly a more sophisticated strategy than the usual "you have hurt the feelings of the Chinese people" kind of diatribe (see Fallows on this front). China has also been less afraid to challenge cases at the WTO, and one form of "retaliation," if there is to be one, may be filing for cases against the U.S. at the WTO. Therefore, a looming bilateral "trade war", as some have suggested, seems an exaggeration. A more likely scenario is what my senior colleague Evan Feigenbaum has astutely observed:

But precisely because both governments' tolerance for trade conflict is rising, decision-makers on both sides appear to have concluded that such disputes can be managed without undermining the entire U.S.-China relationship. Hu Jintao's upcoming visit to Washington should also stabilize political relations through the first half of 2011. Put simply, trade conflict is here to stay, but it is fast becoming a "new normal" in U.S.-China relations. The most disruptive risks lie not in bilateral economics but in geopolitics and in Chinese domestic politics.

Both sides ought to get used to this "new normal".