Talk of Trade Wars with China, Tariffs, and Currency Manipulation Move to Forefront; US Trade Imbalance - Whose Fault is It?

Congress is one again shaking its currency-manipulation rattle. What's different this time is Geithner appears to be listening.

Please consider Geithner signals U.S. patience waning on China currency.

Treasury Secretary Timothy Geithner indicated U.S. patience on China's currency policy was wearing thin on Thursday as a key lawmaker warned that he would move soon on legislation that would penalize Chinese goods.

Striking his toughest tone on the yuan since delaying a decision in early April on whether to name China a currency manipulator, Geithner told a U.S. Senate hearing Chinese policies had a harmful worldwide impact.

"A stronger renminbi would benefit China because it would boost the purchasing power of households and encourage firms to shift production for domestic demand, rather than for export," he told the Senate Finance Committee.

"The time is long past for any Treasury Department to admit publicly what everyone else already knows, that China is manipulating the value of its currency in order to gain an unfair advantage in international trade," said Charles Grassley, the senior Republican Senator on the committee.

Democratic Senator Charles Schumer told Geithner to "be prepared" because lawmakers would move forward soon with legislation that would slap anti-dumping penalties and countervailing duties on goods from China and other countries with a "fundamentally misaligned" currency.

Senator Graham Threatens Veto-Proof Currency Legislation

Congress is increasingly frustrated with the China's currency peg, so much so that senators suggest there may be enough votes to override a presidential veto. Bloomberg reports Graham Says China Yuan Measure Has �Huge� Support in Congress.

U.S. Senator Lindsey Graham said legislation aimed at getting China to raise the value of its currency has �huge� support in Congress, and President Barack Obama �runs the risk� of being overridden if he vetoes it.

�The frustrations with China�s trade practices are growing by the moment,� Graham, a South Carolina Republican, said in an interview on Bloomberg Television�s �Political Capital with Al Hunt,� airing this weekend.

He called the measure a �test� of the administration because Obama �campaigned that he would stand up to China currency manipulation.� Graham has joined Senator Charles Schumer, a New York Democrat, in sponsoring legislation targeting China�s yuan.

Lawmakers are pushing for a vote on the Senate floor this month and want Obama to take a harder line on China. Graham has said there is pressure from the administration to stop the measure from moving ahead.

While Treasury spokeswoman Natalie Wyeth declined to comment on Graham�s remarks, Treasury Secretary Timothy Geithner has resisted efforts at trade sanctions in favor of talks that would lead to a higher yuan.

�The distortions caused by China�s exchange rate spread far beyond China�s borders and are an impediment to the global rebalancing we need,� Geithner said in testimony yesterday to the Senate Finance committee.

�It�s very important for China to understand,� that the Schumer-Graham legislation �has very broad support� from Democrats and Republicans, Geithner said.

The Blame Game

OK the US has a trade deficit. Whose fault is it?

For starters much of the US trade deficit is related to oil. Ignoring oil, what about the trade deficit with Asia, in particular China?

In retrospect, some of the blame (arguably most of the blame) belongs on the US for keeping interest rates too low, too long in the wake of the the 2000-2001 recession.

That disastrous policy decision by Greenspan, continued by Bernanke, fueled an enormous borrowing spree culminating in the biggest housing bubble (debt bubble), the world has ever seen.

The global economy is still suffering the consequences of Greenspan and Bernanke's misguided efforts to spur growth by consumer spending.

More importantly, here we are again, except this time there is no housing or commercial real estate bubbles to blow and thus no source of jobs either.

The magic of Accounting Identities

Michael Pettis discuses trade imbalances and who's to blame in The RMB and the magic of accounting identities

One country�s surplus is another�s deficit

If the US runs a capital account surplus, it must run a current account deficit, and if China runs a capital account deficit, the US must run a capital account surplus. This all nicely balances out because if the US runs a current account deficit, China must run a current account surplus.

These things must all happen simultaneously, and there is nothing in the accounting identities that tells us which caused the other.

If PBoC intervention forces a capital account deficit on China, as Krugman says, then all those other things follow automatically. Alternatively, if Americans decided independently to go on a consumption binge that forced the US into a current account deficit, then all these other things must also follow automatically.

Given the sheer size of PBoC intervention, the tremendous concomitant need to sterilize and repress interest rates, and the resistance to appreciate the currency, it seems pretty clear to me that at least part of the reason for PBoC capital exports was as a policy choice.

Now if the initial cause was the PBoC capital exports, of course the Fed could possibly have foiled the capital impact of the PBoC intervention by raising interest rates and forcing up unemployment in the US.

For whatever reason, right or wrong, the Fed didn�t do this.

[Stephen Roach] makes the point �America needs deficit reduction and an increase in personal saving, while China needs to stimulate internal private consumption.�

These are not separate issues. One can only occur with the other, so we are left with the problem of where the original distortion lies and how to resolve it.

[Quoting Stephen Roach] "Some of America�s most prominent economists are claiming that a revaluation of the renminbi vis-�-vis the dollar would not only create more than 1m jobs in the US but that it would inject new vigour into an otherwise anaemic global recovery. Economists should know better. Changes in relative prices are the ultimate zero-sum game � they re-slice the pie rather than expand or shrink it."

He is of course right here. Ignoring the long-term impacts on growth in China and abroad, the currency game is a zero-sum game in the short term. It is a tug of war over employment, and that is exactly why China wants to maintain an undervalued currency and the US and Europe want it to revalue. This also suggests why, for all the recent signs of thawing, this issue is simply not going to go away as long as global unemployment is a problem.

We can resolve this problem concertedly and intelligently with the minimum cost to the global recovery (which means that Germany, Japan, and Europe have to be involved in the adjustment), or we can do so in a series of beggar-thy-neighbor confrontations. It is unlikely that the latter will involve the least cost to the global economy since the whole point of the strategy is not to minimize cost but to push as much of it as possible onto your neighbor.

Regardless of who is to blame (in my view both the US and China), it does not appear this will be resolved in a mutual love-fest. Escalating beggar-thy-neighbor tactics and disastrous tariffs may be just around the bend.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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