Alan Tonelson: China’s Currency Policy Disadvantages US-made Products and Costs American Jobs
On October 26, 2011, FutureofUSChinaTrade.com director Molly Castelazo caught up with Alan Tonelson, Research Fellow at the U.S. Business & Industry Council Educational Foundation, to talk about China’s currency policy, which Tonelson says keeps the RMB significantly undervalued relative to the dollar and – more importantly – creates tremendous and completely artificial competitive disadvantages for U.S.-made products.
Tonelson acknowledges that China’s currency policy makes Chinese goods cheaper for U.S. consumers, but asks, “What should we value more: cheap goods, or jobs?” He articulates what is, in his view, a much better and more durable formula for national prosperity: saving, investing, and producing at least as much as you consume. And he explains what he sees as the optimal US policy response to Chinese currency manipulation, and the likelihood that U.S. policy action would trigger retaliation by the Chinese. Listen to the full version (approx. 44 minutes) of our conversation and/or read the full transcript below.
FutureofUSChinaTrade.com: Let’s start off with the 101 background: give us an overview on the valuation of the RMB – how undervalued do you think it is, and what effect that has on the different stakeholder groups (American economy in general, American workers, businesses).
Alan Tonelson: Let’s start off with the very important proposition that’s all too often lost in this debate about currency values. That proposition is that the best measure of the degree to China’s undervaluation has little to do with the absolute levels of the exchange rate between the yuan and the dollar at any particular time. The degree to undervaluation instead reflects the gap between the yuan’s valuation on any given day as set by the very narrow trading band set by the Chinese government daily on the one hand and the value that the yuan would achieve if it were allowed to be freely traded, which means if its value were allowed to be determined by investors' judgments about Chinese economic fundamentals and Chinese financial fundamentals, on the other hand.
I make this point because there is widespread agreement even among many critics of Chinese currency policy that since July 2005 when China relaxed what had been a very strict peg between the yuan and the U.S. dollar that the degree of yuan undervaluation has fallen, i.e. the yuan has moved closer to fair market value because in absolute terms its value against the U.S. dollar has risen. There’s no doubt that the yuan has risen in value against the U.S. dollar but that’s not to say that it’s less undervalued today than it was back in 2005, and the reason is that China’s economy and China’s national finances have become so much stronger. So we’re dealing not with a static target but with a dynamic target, that is to say Chinese economic fundamentals and investors’ perceptions of those fundamentals.
**5:00**
So that’s why it’s clear in the U.S. Business and Industry Council that despite this movement seen in the exchange rate since July 2005 the yuan looks even more undervalued today than it did back then because the Chinese economy and its national finances are so much stronger.
This matters very decisively for US-China trade flows and for the future of the U.S. economy largely because China has become such a large trade partner, or trade competitor, of the United States. And of course an undervalued yuan makes Chinese-made goods artificially cheap versus goods made in the U.S. and in other countries. It makes China’s goods artificially cheap not only in the Chinese market and the U.S. market but in third country markets where U.S.-based and Chinese-based manufacturers compete.
This price advantage that is currently enjoyed by Chinese-made goods and that had been enjoyed by Chinese-made goods for many years now has nothing to do with free market forces; it has nothing to do with free trade. It is solely the product of Chinese government decisions. And clearly when Chinese goods enjoy a substantial price advantage over their U.S. counterparts, they’re likely to do much better when it comes to international trade than those U.S. counterparts. That’s not to say that price is the only determinant of trade success, but it’s obviously a very important determinant.
**7:30**
Since the U.S. Business and Industry Council believes that the yuan is presently undervalued by at least 40 percent, it’s easy to understand why China’s currency manipulation creates tremendous and completely artificial competitive disadvantages for U.S.-made products.
**7:50**
FutureofUSChinaTrade.com: So two questions following on that thought. One is: While it creates a disadvantage to U.S. manufacturers who are trying to compete in the same markets, does it create a benefit to American consumers, and others, because they can buy these goods more cheaply?
**8:25**
Alan Tonelson: Well that cheap goods argument is of course often made by supporters of the US-China trade status quo, but it’s very important to remember that economically speaking, few human beings, and certainly few Americans, have a single dimension, i.e., few Americans are strictly consumers when you’re talking about them in economic terms. Most Americans have to work for a living; they have to earn income. There are obviously those lucky few who have inherited wealth, etc. But most Americans have to work for income.
When that reality is recognized it becomes clear that these cheap Chinese goods exact a very high price, i.e. they significantly reduce employment and therefore the income or the opportunities that are available to Americans. They significantly reduce not only American employment rates but they can also reduce American wage levels. So it really comes down to the question of what should we value more: cheap goods, or jobs?
Should we value more the ability to purchase artificially underpriced products or should we value more the preservation and strengthening of income opportunities? To me, and I think to most Americans, the answer is clearly that jobs or income-earning opportunities are a much better foundation for national prosperity, certainly over any length of time.
**10:35**
Now, having said that, it’s also very important to point out that there is one other set of clear U.S. winners resulting from China’s currency policy. And those winners at least in the near-term sense are U.S.-owned companies that produce goods for export in China. They benefit significantly from yuan undervaluation because it provides them with a substantial subsidy that can lower the prices of the goods they make in China vis-à-vis US-made competition.
So China’s currency undervaluation represents a major subsidy for offshored American production or U.S. multinational-related production; it has greatly enhanced the price competitiveness of their products and it’s very obvious that this is a subsidy that’s quite valuable to them; the status quo in currency benefits them tremendously and they are fighting very hard to preserve it.
I would add, by the way, that this stance of theirs is extremely shortsighted because – and this actually opens up a whole new series of issues – there is widespread consensus in the economics community that the enormous US-China economic imbalances that are caused in large part by predatory Chinese economic and trade policies like currency undervaluation bear great responsibility for the economic and financial crisis that engulfed not only the United States but the entire world starting in the summer of 2007 when the U.S. subprime mortgage market began melting down. Clearly, this economic and financial crisis has damaged the interests of the U.S. multinational corporations also. But few of them seem inclined to take that longer view, because the American financial system creates such outsized rewards for short-term success and places such little value on longer-term success.
**13:30**
FutureofUSChinaTrade.com: So that brings to mind a question about the U.S.-based multinationals. I spoke a few months ago with Jim Owens, who was the CEO of Caterpillar. We didn’t talk at all about the currency issue, but Jim made a comment that because Caterpillar does business – sells in China – that business allows the company to employ U.S. workers here in the United States. Is there that benefit that if the MNCs can succeed in China and other places then they can employ more workers here at home?
Alan Tonelson: I’m sure there are individual instances of that dynamic playing itself out, and Caterpillar in part appears to be one of them – and I’ll explain why I’m qualifying that shortly. But if you look at the trade flows of U.S. multinational companies and you look at the performance of U.S. multinational companies, which are both tracked by the U.S. Commerce Department, it is impossible to argue that these companies’ foreign operations make a net contribution to U.S. economic growth or to U.S. job levels. The reason that we know this is that the U.S. multinationals run a large and growing trade deific – i.e., they import much more than they end up selling to the rest of the world, and they hire many more workers overseas than they hire in this country.
**15:40**
But getting back to that trade balance point; since trade deficits subtract from GDP, and since growing trade deficits subtract from economic growth, it’s impossible to say that multinational company operations add to either one or strengthen the U.S. economy or enrich it in any way. Now, that’s multinational companies overall. Caterpillar is very unusual. When talking about Caterpillar, it’s important to remember that although Caterpillar has indeed maintained a very substantial U.S. employment footprint it has done so in large part by dramatically reducing its workers wages. That seems to be at best a very Pyrrhic victory for the American labor force.
It’s also important to note that although Caterpillar is always very happy to tout its exports from the U.S. it has been unwilling so far to disclose publicly what it imports. So until we get those numbers from Caterpillar we really won’t be able to know how Caterpillar’s trading operations affect the U.S. economic fortunes.
One final point about Caterpillar that’s rather distinctive: Caterpillar is one of relatively few American companies that make products that are actually consumed in China. It’s one of relatively few American multinational companies certainly that make products that are sold in final form in China, i.e. that are shipped in final form from the U.S. to China and to many other foreign countries as well. A very large percentage of U.S. exports to China – we don’t know exactly how many because the U.S. government isn’t very good at counting them – consist of industrial inputs of all kinds: parts, components of larger manufactured final products, but also capital equipment, which goes into building foreign factories. Lots of the final products that are created from U.S. exports come back into this country, fueling trade deficits. How do we know this? Because China’s economy has for so long been an export-driven economy; exports have accounted for such an outsized share of China’s economic growth.
Caterpillar is very unusual, though, in the sense that it’s very easy to make the argument that even though in a technical sense Caterpillar’s products are consumed in China, many of them are used to strengthen the Chinese export base. Why is this? Because so many types of Caterpillar machines go into building infrastructure systems, and so many of China’s infrastructure is geared toward exporting. So Caterpillar is a little unusual.
**19:20**
FutureofUSChinaTrade.com: Some of the most free market of the economists that I’ve talked to before would say, “Well okay, China manipulates its currency, and that has damaging effects on the U.S. economy, but on whole the U.S. economy is better off because we trade with China, and eventually they’ll have developed enough that they’ll stop it. So there’s not really anything we need to do about it.”
Alan Tonelson: There’s no doubt that the vast majority of the economics community, while probably not happy with China’s policy of currency manipulation, would agree with the proposition that the only thing worse than acquiescing in this process would be responding to it with trade barriers.
My main reason for disagreeing strongly with those views is back to the point I made earlier about jobs versus cheap consumer goods. The idea that the U.S. benefits, either presently, or has benefited in the past, or will benefit in the long run, is based largely on the idea that cheap consumer goods are themselves a tremendous benefit for the American economy and for many Americans and their families, but also for American businesses, who get various types of supplies and inputs at prices lower than they would normally pay.
In my view the problem with such thinking is that it assumes that prosperity can be maintained primarily by consuming and by net importing and therefore by engaging in the type of borrowing that’s required to finance those imports. And certainly common sense tells me that that’s a very shaky recipe for national prosperity over any period of time. And in fact the enormous debts that this country has run up, largely due to its international trade policies and the deficits that they’ve created, as I’ve previously argued, bear much responsibility for the economic and financial crisis. I think that this record of recent years bears me out. That is to say a much better and more durable formula for national prosperity is saving, investing, and producing. And certainly producing at least as much as you consume.
**22:40**
FutureofUSChinaTrade.com: So what’s the optimal mechanism by which the U.S. should go about effecting a change in the relative value of the RMB?
Alan Tonelson: It could be the WTO in theory, but that actually brings us to a fundamental misconception about the World Trade Organization – the idea that it’s roughly akin to an American court of law where all parties to a dispute can have a reasonable assurance of a fair outcome that’s meted out by reasonably impartial magistrates or jurists who interpret a well-established code of law. In my view it’s clear that that description does not fit the World Trade Organization at all; that it is an entirely political organization with legalistic and judicial trappings and that the politics of the WTO is very heavily anti-American. And the reason is that the WTO membership is numerically dominated to an overwhelming extent by countries that have a great stake in keeping the U.S market much wider open for their goods than their markets are to U.S. goods. And in fact most WTO countries are much closer to China in trade policies than they are to the U.S.
So in my view the WTO will not provide an effective means for promoting or defending U.S. economic interests vis-à-vis China. And in my view the very best response would be a stiff U.S. tariff that would raise the price of Chinese-made goods – including those goods that come out of the factories owned or related to the operations of U.S. multinational companies – would raise the price of those goods relative to the price of the US-made goods with which they compete.
And in fact I’m glad that you didn’t ask me what my preferred policy for increasing the yuan’s value was or for changing Chinese policy was. Because I don’t think that is a promising goal for Washington to pursue. In large part because currency undervaluation is only one type of what we call predatory trade policy that China engages in to rig trade markets. I and the USBIC generally speaking have been somewhat concerned that the tight focus of so many U.S. policymakers on currency issues might blind them to the ease with which China can shuffle predatory trade policies around and basically take away with one hand what it gives with the other hand. In fact China has engaged in just this kind of subsidy shuffling act before. I would hate to see American leaders fall for it once again. That’s why I say the best response would be tariffs that ensure higher prices for Chinese-made goods sold in the U.S. market regardless of the subsidy from which they benefit.
**27:40**
FutureofUSChinaTrade.com: How do you respond to people who say, “If the U.S. imposed tariffs on Chinese-made goods, that would spark a trade war. China would then impose tariffs on U.S.-made goods and it would snowball from there.” How do you respond?
Alan Tonelson: In my view Chinese retaliation would amount to a decision by Chinese policymakers to shoot themselves in the head. The reason I say this is a) because China’s economy does rely so heavily on net exports to create growth and also jobs and b) the United States is by far the best end-use customer for Chinese products. So it would amount to both economic and possible political suicide for the Chinese policymakers to antagonize the best customer for their export-dependent economy. The politics of this situation are critically important to understand. One main reason that China has clung so tightly to this policy of currency manipulation is the very urgent need for the economy to create jobs and maintain employment by exporting.
There’s a tremendous and I think quite amply justified fear on the part of the Chinese leadership that significantly higher rates of Chinese unemployment – the kind of jobs crisis that could well result from a sharp reduction in Chinese exports – could threaten Chinese political stability and in fact could threaten the Communist Party’s hold on power. Chinese history teaches us that there are few things worse in life than being a former Chinese leader. And I will continue with this quote: It’s bad for your health. So staying in power is the number one priority of the Chinese leadership. And that is one reason why – as painful as it will be for that leadership to deal with the kind of export slowdown that would certainly result from U.S. tariffs, it would be even more painful for them to engage in a trade war which would result in them losing even more of the U.S. market than that first round of tariffs would actually cost them.
There’s no doubt in my mind that in this relationship the U.S. holds all of the most important cards; it’s simply that Washington refuses to recognize this. Or at least the critical mass of U.S. leadership so far refuses to recognize this.
FutureofUSChinaTrade.com: So what are the prospects that policymakers in D.C. will actually impose some tariffs?
Alan Tonelson: In the larger sense, the longer the U.S. economy continues to stagnate, the more pressure voters will put on their leaders to do something about it, and much of this pressure will center on countering predatory trade policies like currency manipulation. Having said that, there is also a very distinct possibility that the U.S. economy will be able to muddle through just well enough to prevent popular emotions from reaching that boiling point. If the economy substantially worsens, the odds of effective action against Chinese mercantilism in my view go up significantly.
There’s no doubt that the fate of the current currency bill is very much up in the air right now. It’s clear that the House Republican leadership strongly opposes this bill and does not want it brought to a vote – precisely because from all that we know about its current levels of legislative support, it would pass. It currently boasts 230 co-sponsors – that number has actually gone up in the last few days – and 63 of them are Republicans. So that’s a pretty good bi-partisan majority.
In principle the rules of the House enable Speaker Boehner to exercise great control over that Chamber’s agenda. At the same time, there is a possibility of a so-called discharge petition, which is a legislative device that enables bills to move to the House floor for a vote despite leadership opposition. Such a discharge petition requires a simple majority of the House. It hasn’t moved so far because even House Republicans who have co-sponsored the actual currency manipulation bill itself are very reluctant to sign that discharge petition for fear of antagonizing their own party’s leadership. However, again, as America’s economic problems continue and possibly worsen, the pressure on those legislators will certainly rise.
**34:40**
FutureofUSChinaTrade.com: Have you conducted analysis or do you know of analysis that exists on how many American jobs would be created or how much would be added to GDP if certain tariffs were imposed and American-made exports were more competitive?
Alan Tonelson: The only studies that profess to provide highly-specific answers to those questions come from the Economic Policy Institute. But they provide an answer to a slightly different question: they purport to show how job creation in this country would be affected if the yuan were traded at fair value. That’s of course a slightly different set of conditions than the imposition of U.S. tariffs that are aimed of course at equalizing prices of the goods that the two countries trade.
What we do know is that all else equal, any action that reduces the trade deficit speeds up growth, increases GDP, and therefore by definition must increase U.S. employment. In fact, I’ve written most recently for Bloomberg News that the only way for the U.S. economy to speed up growth in hiring without incurring more debt is to dramatically reduce its overall trade deficit (and of course the China trade deficit is the huge component, currently about 40% of the total U.S. goods deficit).
FutureofUSChinaTrade.com: President Obama has said that he wants to double U.S. exports in five years. Do you see any path to doing that that doesn’t involve tariffs on Chinese-made goods?
**38:10**
Alan Tonelson: Let me first point out that the President’s goal reflects a shocking degree of economic illiteracy. The reason is that increasing exports per se will do absolutely nothing to achieve his goals of boosting GDP growth or employment. Changing trade flows can only improve growth and job creation if the trade balance improves. Therefore, what has to go up is U.S. net exports. I’ve seen no prospect of the President contributing in any way to a doubling of net exports over an y foreseeable period of time. Even if he wins a second term. Again, what has to go up are net exports. Given the enormous disparity between American exports and American imports – or let’s say, given the strong likelihood that the world economy will remain very fragile for a long time to come and that because growth will be subdued, foreign markets are not likely to remain even as open to U.S. goods as they are now, it’s clear that a great deal of the trade deficit reduction will have to come from curbing American imports. Not all of it, but lots of it will.
FutureofUSChinaTrade.com: And that’s curbing imports by making more goods for consumption here at home?
Alan Tonelson: Well, it would involve replacing much of what we currently buy from oversees with what we would make at home. And the way that we see it, that kind of import substitution holds the greatest potential to achieve that deficit reduction goal that is so essential to generating debt-free growth. And in fact, just to amplify slightly, over the last few years, this country has proven to be moderately successful at creating growth and jobs while piling on enormous amounts of new debt. Very few Americans are happy with that. The challenge we face is to grow and create more jobs while reducing those debts. That’s what trade deficit reduction enables a country to do.
As long as President Obama remains so tightly wed to the trade policy status quo – not only regarding China, but regarding the World Trade Organization, regarding the types of trade agreements that the U.S. signs with various trade competitors, regarding future proposals like the Asia-Pacific partnership...as long as U.S. trade policy strategy remains the same, the results – which is to say, enormous and growing deficits – will remain unchanged also.
**42:40**
FutureofUSChinaTrade.com: So it sounds like it’s going to come down to if American voters feel enough pain, are they going to vote in policymakers who will change the status quo.
Alan Tonelson: It’s a very depressing scenario to consider, because everyone wants the economy to do well, but it does seem that considerably more pain is going to have to be inflicted on the American voter before they generate the kind of pressure on leaders to produce that trade policy change.
