It is Time for a New Economic Stance on China

Op-ed in the Financial Times

September 29, 2004

A Republican president faces re-election. His tax cuts have plunged the budget into record-breaking deficits, accompanied by an overvalued dollar, and a trade gap of unprecedented magnitude. The Congress is growing restive, and protectionists are on the march. Re-election is far from assured.

The Treasury Secretary, a former corporate CEO, knows that he must sell tens of billions of dollars of bonds every month to keep interest rates from tearing through the roof. He scans the globe looking for the deep-pocketed customer who can keep sales up and his boss employed, when his practiced salesman's eye comes to rest in the Far East. They have got plenty of savings to invest, but there's a catch: The local law blocks prospective customers from making the purchase in US dollars. But for every problem there is a solution, and in this case it is straightforward: get the law changed, get the capital flowing out, and get the boss re-elected. Ronald Reagan and Donald T. Regan in Japan in 1984? Wrong. Try George W. Bush and John Snow in China, 2004.

With America's election year trade deficit heading toward $600 billion and the bilateral imbalance with China accounting for perhaps one quarter of the total, the Bush administration has been under intense political pressure to "do something" about China. Twice this year the administration has rejected petitions from unions and manufacturers seeking protection from the Chinese onslaught. But recent Treasury statements suggest that in a battle between Wall Street and Main Street, the administration has sided decisively with Wall Street's financial interests.

A US Treasury statement of September 9, when the administration refused the Section 301 petition of the self-styled China Currency Coalition (CCC), follows the pattern set by its predecessors by emphasizing the desirability for China to liberalize capital market outflows and integrate foreign (read US) financial services firms into the Chinese market. In both respects it is eerily reminiscent of the Treasury's line more than 20 years ago in Yen-Dollar Talks, which successfully liberalized Japanese capital outflows, facilitating the purchase of billions of dollars of Treasury bills by Japanese investors and the re-election of Ronald Reagan. But it also contributed to the depreciation of the yen, widening trade imbalances, and fractious trade relations.

When the talks were announced in 1983, the exchange rate stood at ¥232 to the dollar, the US trade deficit was under $60 billion and the bilateral deficit with Japan was $20 billion, figures that seem almost quaint in retrospect. Within a year of the conclusion of the negotiations in 1984, the yen had depreciated to ¥265 and James T. Baker, Donald Regan's successor, was organizing an international effort to bring down the soaring dollar and forestall protectionist actions in Congress. By 1987 the overall deficit stood at more than $150 billion, the bilateral imbalance accounted for more than one third, and Baker was reduced to publicly boasting that his boss had imposed more protection than any president since Herbert Hoover.

A wise man once observed that history repeats itself, appearing first as tragedy then as farce. As in the 1980s, Congress is getting into the act: Legislation has been introduced, which would threaten China with WTO and IMF sanctions if it does not float its currency. The bill is currently bottled up in the House of Representatives, and the House leadership is unlikely to do anything between now and the election to embarrass the president. John Kerry, the Democratic presidential nominee, has avoided signing on as a co-sponsor of the legislation in the Senate, so a holding pattern is set until after the November elections regardless of who wins the Presidency.

Rather than reviving the economic diplomacy of the 1980s, the next administration should push for a one-time renminbi revaluation of perhaps 15 to 25 percent under China's existing exchange rate management system. From a Chinese perspective the revaluation would contribute to the cooling of the Chinese economy and would discourage additional speculative inflows that are affecting China's already shaky banking system. However, unlike the current Bush policy, a step revaluation would give China time to stabilize its banking system before subjecting it to the vagaries of the international capital market. A step revaluation could also facilitate a more general realignment of Asian exchange rates that would be a welcome component of global adjustment, as opposed to the likely short-run depreciation of the renminbi under the Bush approach.