June 1, 2006 Topic: Economics


Mini Teaser: Protectionist measures endanger America's financial well-being.

by Author(s): Stephen S. Roach

The U.S. Congress is on course for a dangerous slide down the slippery slope of protectionism, and a politically weakened White House is in no position to stop it. China is the lightning rod in this debate. As a senior Washington insider confided to me recently, "Concerns over China are boiling over in this town." While extreme actions on the tariff front have been deferred--at least for the moment--it is starting to look as if an even bigger train has left the station. The angst of worker insecurity is proving to have irresistible bipartisan appeal within the American body politic. The odds are rising that Washington will enact some form of protectionist legislation before the mid-term elections this November.

The good news is that Senators Charles Schumer(D-NY) and Lindsey Graham(R-SC) have once again postponed a floor vote on their proposal for a so-called "currency-equalization tariff" of 27.5 percent that was to be levied on all Chinese imports into the United States--a surcharge they believe would provide fair compensation for an undervaluation of the renminbi by a like amount. When I ran into them in Beijing in late March, they boasted that they had eighty votes in favor of their proposal. There is a new threat of a September 30 floor vote on this measure, but my guess is that this type of extreme legislative action has now fallen out of favor in Washington.

In its place, a less contentious but very hard-hitting legislative option has emerged--the United States Trade Enhancement Act of 2006 (USTEA), proposed by Senators Charles Grassley(R-IA) and Max Baucus(D-MT), the chairman and ranking minority member, respectively, of the Senate Finance Committee. Unlike the Schumer-Graham proposal, this bill appears more palatable to the Bush Administration. In congressional testimony in late March, the Grassley-Baucus option was praised by senior officials from the U.S. Treasury, the Department of Commerce and the Office of the U.S. Trade Representative as a more acceptable alternative to tariffs. This could well represent a sea change in the politics of trade legislation: a bipartisan proposal that enjoys White House support.

In a nutshell, the USTEA rewrites the book on how the United States both identifies and responds to external imbalances and currency "misalignments"--the latter word being a deliberate and important substitute in place of the contentious characterization of outright, pre-meditated "manipulation" that has long plagued the currency dimension of the foreign-trade debate. Terminology aside, the purpose of the legislation is to correct for trade imbalances that are created or maintained when a country intervenes in foreign exchange markets in an effort to prevent its currency from adjusting to market forces. The goal is to safeguard a key premise of the market-based system: fair competition.

The Grassley-Baucus bill empowers a new office in the U.S. Treasury to develop a more sophisticated set of tools to identify those nations guilty of perpetuating such misalignments, and it establishes an important consultation mechanism with the International Monetary Fund (IMF) and the U.S. trade representative to arrive at this determination. Should a verdict of misalignment be rendered, the USTEA offers a broad arsenal of remedial actions to be directed at the offending nation--including restrictions on trade finance, suspension of IMF voting rights and the reclassification of a country's trading status with the United States. Unlike the Schumer-Graham bill, which is a China-specific measure, the Grassley-Baucus proposal is a more general piece of trade legislation. But its sights are certainly set on the elephant in the room--coming to grips with what is by far the largest piece of America's trade gap, a U.S.-China bilateral trade deficit that hit $202 billion in 2005.

Meanwhile, the Senate Banking Committee has been hard at work on another track--a major revamping of the approval process for cross-border mergers and acquisitions (M & A) transactions into the United States. Spearheaded by Committee Chairman Richard Shelby(R-AL), the Foreign Investment and National Security Act of 2006 would put more teeth into the so-called CFIUS mechanism (the Committee on Foreign Investment in the United States). Specifically, the legislation would lengthen significantly (up to 120 days in certain cases) the review time for acquisitions of U.S. companies by state-owned overseas acquirers. Moreover, the bill would automatically trigger national security investigations for transactions deemed to impact America's critical infrastructure (including energy assets), critical technologies, and domestic production linked to national defense requirements. This proposal owes its origins to two highly politicized, and eventually scuttled, foreign takeover attempts: last year's proposed Chinese acquisition of Unocal and the recent Dubai Ports World fiasco.

Like the Schumer-Graham and Grassley-Baucus trade and currency initiatives, the Shelby proposal enjoys broad bipartisan support; on March 30, it sailed through the Senate Banking Committee by a vote of twenty to zero. While the bill still needs to go to the full Senate and then the House of Representatives, there can be no mistaking the bottom line: New sources of friction are being added to cross-border M & A activity into the United States.

These two seemingly disparate strains of congressional activity--one directed at the currency problem and the other focused on foreign investment--have one important thing in common: They are both examples of a dangerous combination of election-year politics and bad economics--politically driven constraints on trade and capital flows that run very much against the grain of the foreign-funding imperatives of a savings-short U.S. economy. The latest data on overall national saving in the United States hammers that point home. America's net national savings rate--the combined savings of households, businesses and the government sector adjusted for depreciation--fell to just 0.3 percent during the second half of 2005. This result is an unfortunate by-product of ongoing federal budget deficits in conjunction with the worst shortfall in consumer savings since 1933. Not only is this a record low for America's overall savings rate, but it is unprecedented for any leading nation in the modern history of the world economy.

Lacking in domestic savings, the United States, must import foreign savings in order to grow. In exchange for that saving, America buys goods produced abroad. That means the United States must run massive current account deficits in order to attract foreign capital. By throwing sand in the gears of trade and capital inflows--precisely the effects of the Grassley-Baucus and the Shelby proposals--America's external funding problem can only get thornier.

Washington is making an especially serious mistake by isolating the "China problem" from these broader macroeconomic concerns. That's not to say that the United States doesn't have grounds for tough negotiations with China on a number of trade issues--especially market access, intellectual property rights and, yes, even the currency. But a reduction of a bilateral trade deficit with one nation will do nothing to resolve what is truly a multilateral problem for a savings-starved U.S. economy. Last year, the United States ran trade deficits with all of its major trading partners. While the Chinese piece was the biggest slice of the deficit--accounting for 26 percent of America's total multilateral trade gap--more than $560 billion of additional deficits was spread elsewhere. The water balloon analogy applies all too well in this instance. Until the United States fixes its saving problems and reduces its claim on the pool of foreign savings, a reduction in the Chinese bilateral deficit will only shift that portion of the shortfall elsewhere. Whether it's Schumer-Graham or Grassley-Baucus, the Washington "remedy" misses this critical point altogether.

The same line of reasoning basically follows with respect to the Shelby-sponsored initiative on foreign takeovers. America needed about $800 billion of capital inflows from abroad to make up for its lack of savings in 2005. Of that total, $128 billion came from overseas foreign direct investment (FDI) last year--an increase of $22 billion from the FDI inflows recorded in 2004. If a revamped CFIUS mechanism impedes those flows--and the Shelby proposal could well do that by lengthening the review time required for takeovers--the external funding will then need to be sourced through a different channel. To the extent those incremental inflows get redirected into stocks and bonds, it would not be unreasonable for increasingly nervous foreign investors to seek compensation for providing those funds to the United States. Any financing concessions most likely will take the form of a weaker dollar or higher real interest rates, or both--outcomes that could in turn spell serious trouble for the U.S. economy. Again, by failing to address the root cause of America's external imbalance--an unprecedented shortfall of domestic savings--Washington could be blindsided by the unintended consequences of the water balloon effect.

In the end, the repercussions of America's newfound protectionist bent go well beyond economics. The risks to cross-border flows of goods, services and financial capital can hardly be minimized. But equally disconcerting is a new sense of distrust that is being injected into America's relationships with the international community. There is nothing easy about coping with the trials and tribulations of globalization. But the United States is now at risk of squandering what could well be the greatest opportunities of global economic integration--the trust that comes from working together with strategic partners. By transforming China into the "competitive enemy" or by characterizing the United Arab Emirates (owner of Dubai Ports World) as a national security threat, Washington runs the risk of tainting some of its most important strategic relationships.

Essay Types: Essay