A Full-Court Currency Press
This Friday the Treasury Department is scheduled to release its postponed report on whether China is engaged in exchange rate protectionism. The administration has warned Beijing that this time China might finally be named as a currency manipulator in the report, which carries great symbolism but no automatic sanctions. The administration is right to press China—particularly since it is in Beijing’s longer-term interests to move towards a more flexible exchange rate policy in order to develop a full macroeconomic toolkit—but the White House needs to remember exactly why it is doing this, act strategically in order to get results, and consider how the currency issue fits into a broader U.S. strategy towards China.
The strategic reason to press China on currency revaluation is because the artificially low value of the yuan risks prompting other nations to drive down the value of their currencies to remain competitive, which increases the dangers of a global currency war. In other words: it is a global problem, not just a U.S.-China problem. The wrong reason to press China for currency revaluation is to stimulate short-term U.S. job creation or seek domestic political advantage in the United States. In short, the United States should avoid uncoordinated unilateral assaults on this issue.
It is not clear which of these motives is driving the Obama administration, though one could guess which is more persuasive in the halls of the Treasury Department and which is bandied about most in the West Wing of the White House or the Democratic National Committee. This last week Democratic candidates engaged in a strikingly well-coordinated series of attack ads on Republicans in swing states where health care legislation and job losses have driven down Democrats poll numbers. The ads typically feature foreboding music with a narrative about how the Republican candidate is helping to export jobs to China. Naming China as a currency manipulator on Friday would play perfectly into this narrative for a desperate Democratic Party that thinks spotlighting the twin evils of China and the U.S. Chamber of Commerce will blunt the Republicans' strong momentum going into November 2.
China needs to move towards a flexible, market-oriented exchange rate and a stronger yuan. But the U.S.-China economic relationship does not exist in a vacuum. While a cheaper yuan would theoretically increase U.S. exports to China, currency revaluation will not bring back lost manufacturing jobs to the United States. Those jobs would simply shift from China to other developing nations as corporations and American consumers hunted for the best bargain. A more serious effort to increase U.S. exports would go well beyond currency issues to address the U.S. savings rate, competition policies (including the negative consequences of expanded government intervention in the U.S. economy), and barriers to trade and investment within China.
Time will tell whether an aggressive unilateral approach on the currency issue makes for good political strategy for the administration and the Democratic Party, but as grand strategy it carries three big risks. First is the risk that the United States will appear isolated, which only increases the likelihood of Chinese retaliation and further distancing by Europe and Asia from the U.S. approach. The second risk is to the primacy of the dollar. If the administration looks too eager to drive down the dollar in order to get out of the financial crisis and escape domestic political heat, markets and governments will draw unhelpful conclusions about the United States’ longer-term commitment to the dollar as the leading reserve currency (building upon existing doubts about the American commitment to fiscal solvency).
The third risk is to the broader U.S. strategy for managing the rise of China. Chinese leaders since Deng have tolerated U.S. efforts to strengthen regional alliances and pressure China on human rights because at the end of the day they believed that the American President was committed to a stable U.S.-China relationship and would control U.S. domestic pressure aimed at undermining China’s economic development. If it looks like President Obama is losing control of his base –something that the Chinese never worried about with Reagan, Clinton or either of the Bushes—then Beijing’s own volatile domestic politics will become far more difficult for Hu Jintao or his successor to control. A vicious cycle of unilateral retaliation on the currency issue could also panic the administration into retreating on other aspects of U.S.-China policy that are no less important strategically, including defense cooperation with allies, arms sales to Taiwan, and attention to human rights—not to mention other barriers to U.S. trade and investment in China.
So by all means, the administration should keep the pressure on China to move to a flexible, market-oriented exchange rate and a higher valuation for the yuan. But they should avoid the domestic political temptation to start a unilateral fight on Friday and wait instead for the more effective multilateral opportunity in Korea at the G-20 meeting scheduled for mid-November.