What's Behind Congress Taking on China's Currency Policy

China's currency may or may not still be under valued, but looming political obstacles will likely keep U.S.-Chinese policy from being determined at a national level

ma oct 5 p.jpg

There are two divergent, and competitive, strains of thought on the U.S.-China economic relationship. They can be essentially summarized as "carrot" or "stick" approaches to managing Chinese competition during a time of high unemployment in the U.S. One is the China currency legislation, revived this week with notable support in the Senate -- the stick. The other is attracting Chinese money to create new jobs and investment, especially in cash-strapped states -- the carrot.

It is understandable that long-time observers of congressional politics might roll their eyes at the thought of another China bill during election season, with the same cast of characters (yes, Chuck Schumer, Democrat of New York). And some may even wonder how you sell a currency bill when the Chinese yuan has been appreciating since last year, as shown in the screen shot below:

ma screenshot currency.png

The pace of appreciation has been uneven, of course, with noticeable spikes but also a slow down in September. But the trajectory is unambiguous. So the argument, then, is that the Chinese currency is still undervalued (most economists agree) and so it must appreciate more and faster (there's less agreement about how much). If one recalls Senators Schumer and Lindsey Graham's first attempt at a China currency bill in 2005, it was stipulated that the Chinese yuan was undervalued by 27.5 percent. Until recently, Fred Bergsten of the Peterson Institute proclaimed that the Chinese currency remained another 30 percent below its actual market value, but now seems to have changed his mind. Since 2005 when China formally de-pegged its currency from the U.S. dollar -- discounting the pause during the financial crisis -- the yuan has had nominal appreciation of nearly 30 percent, exceeding what Schumer and Graham deigned in their original legislation.

So why the revival now? One obvious answer is the fleecing of American manufacturing jobs, which the supporters of the bill seem to agree is largely caused by China engaging in unfair trade practices -- such as currency manipulation -- at the expense of U.S. workers' livelihoods. In an environment of 10 percent unemployment, it is a compelling political argument that aligns with President Obama's reelection platform of jobs, jobs, and some more jobs. Or it may just be a principled stance to hold China accountable, as Paul Krugman, the political pundit, argues, even as the economist in him readily concedes the this action won't come close to ameliorating our economic woes. There is likely another motive this time, however, that involves a bargain on trade, as the WSJ reports:

Adding to the pressure, free-trade deals with Panama, South Korea and Colombia are coming before the Senate soon. Critics of the pacts say they will hurt American workers, and lawmakers who support the China currency bill may find it easier to vote for the trade deals.

Free trade deals in exchange for smacking China for its maligned currency policy -- does this mean it is yet again political theater? Not necessarily, since the margin of vote in the Senate could help support the bill and as the House caves to pressure, sending the bill to President Obama's desk. Sean West, U.S. politics analyst at Eurasia Group, explains in a note:

...however, the bill could pick up momentum if the bill receives 70 votes or more in the senate. That momentum could be reinforced by a 15 October decision by the Treasury Department to either decline to label China a currency manipulator or to delay its decision (there is little chance Treasury will actually label China a manipulator). While GOP leadership prefers not to proceed with the China bill, it is far from clear whether it wants to spend much political capital to kill it. Indeed, strong pressure from rank-and-file members could convince the House leadership that it is better to let the bill-or an alternative -come to the floor, where it is likely to pass.

Ultimately, however, I would be very surprised if the White House went along with this bill. Indeed, the administration has ostensibly tried to keep the bilateral relationship on an even keel, preventing major volatility as each country undergoes important political transitions. Moreover, the U.S. Treasury has been loathe to label China a "currency manipulator" in its semi-annual reports to congress. The Taiwan arms sale has been another recent example, with the island's looming elections next year adding uncertainty to the U.S.-China relationship.

The relatively restrained pro forma response from Beijing on the currency bill seem to reflect an understanding of the current situation, with Beijing doing its part to not worsen the tension. In predictable official repudiation mode, news agency Xinhua collated official statements from the various Chinese ministries and enlisted foreigners ("allies") who agree with the Chinese view. The firebrand Ma Zhaoxu at the foreign ministry is "unwaveringly against U.S. congress' action"; then the commerce ministry, more modestly, inveighs that the "action violates the WTO and arouses deep concerns from China"; and finally, the eminently rational People's Bank of China makes the economic case that "...the value of Chinese currency is not the main contributor to bilateral trade imbalances, which are caused by various structural factors...". Yes, each bureaucracy stuck faithfully to its talking points.

Yet as this issue plays out in the immediate term, an entirely different meme is shaping the relationship in the long run: follow the Chinese money. It is well-known that an outcome of China's currency policy has meant the endless accumulation of foreign exchange reserves, which stands at about $3.2 trillion, or half of China's GDP, most of which are denominated in U.S. dollars. That growing figure has become emblematic of bilateral trade imbalances and it is turning into a liability for the Chinese government.

Beijing's policy has never been about "dumping Treasuries" but about diversifying out of them. This logic is all the most salient given a depreciating dollar and dysfunctional politics in Washington that brought the debt-ceiling issue to the brink. These massive piles of U.S. T bills can get better returns if re-invested into U.S. assets with solid long-term returns. And, for our part, why wouldn't we want our money back?

Debate over Chinese investment in the U.S. is fierce, even as various state governors/city mayors have trekked to Beijing to pitch to investors--for instance, this Maryland story. At last week's Washington Post Live China conference (videos here), I sat in on a panel that was devoted entirely to the subject of getting Chinese money. David Rubenstein, head of private equity behemoth Carlyle Group, was an ardent advocate of making it easier for China to deploy its capital to create American jobs (operative words here). Others are expressing similar ideas -- see this Asia Society report, for example.

Yet it is undeniable that Chinese investments face considerable political obstacles in Washington for a host of reasons: national security concerns, perception of Chinese intentions, the state's role in Chinese companies, and so on. But a different story may be unfolding at the state level, which could affect national politics and attitudes. How do you reconcile Schumer haranguing China on its currency policy with the Illinois governor getting Chinese Goldwind to build wind farms in the state?

The heightened political season makes it difficult to discern which direction the politics will eventually break. But it seems to me that states' receptivity to Chinese investment will have the potential to alter the national political landscape in the longer term.