Is a Trade War with China Brewing?

Chinese Premier Wen Jiabao yesterday firmly rejected calls for a stronger yuan, which is widely credited for boosting the country’s exports and maintaining its enormous trade surplus. “The Chinese currency is not undervalued,” he said on Sunday in Beijing. “We oppose all countries engaging in mutual finger-pointing or taking strong measures to force other nations to appreciate their currencies.”

The Chinese have been asserting for some time that revaluing the currency was a non-starter. Earlier this month, China’s central bank chief said as much, as we discussed here. Wen’s comments yesterday only strengthen his country’s resolve.

“I understand that some countries want to increase their exports,” Wen said, “but I don’t understand the practice of depreciating their currency and forcing others to appreciate theirs in order to accomplish this. I think this is a type of trade protectionism.”

Paul Krugman didn’t use the P word in his New York Times column today in “Taking On China” over its “policy of keeping its currency, the renminbi, undervalued.” He didn’t need to. It was hard to ignore the protectionist implications in Krugman’s recommendation of imposing a temporary surcharge of 25% on Chinese imports coming into the U.S. “I don’t propose this turn to policy hardball lightly. But Chinese currency policy is adding materially to the world’s economic problems at a time when those problems are already very severe. It’s time to take a stand.”

Perhaps, but protectionism, whether you call it that or not, comes with a fair amount of economic risk. Nonetheless, “Despite the economic arguments against it, protectionism has an undeniable political allure,” write William Baumol and Alan Blinder in their textbook Macroeconomics: Principles and Policy. “It seems, superficially, to ‘save American jobs,’ and it conveniently shifts the blame for our trade problems onto foreigners.”

For good or ill, noises from both Republicans and Democrats these days seem to favor some form of retaliation for China’s artificially weak currency. According to BusinessWeek:

U.S. lawmakers, including Senator Charles Schumer, are proposing that China be hit with stiffer tariffs to compensate for the unfair export advantage they say comes from an undervalued currency. Economist Paul Krugman estimates that global growth would be about 1.5 percentage points higher if China stopped restraining the value of the yuan, and after Wen’s comments said the U.S. should consider putting a 25 percent surcharge on Chinese goods.

“Chinese officials are alone in their refusal to acknowledge that the yuan is undervalued,” Senator Charles Grassley, an Iowa Republican, said in a statement responding to Wen’s remarks. “If they choose to stick their heads in the sand, we’ll have to find another way to address this problem because it’s been going on for far too long.”

Expect more of this tough talk on trade policy in the U.S. as mid-term elections in November draw near at a time when the U.S. continues to suffer from a weak labor market and a risk of sluggish economic growth. “There’s nothing off limits when election-time comes around, and China makes themselves an easy target,” Ralph Cossa, president of the Pacific Forum at the Center for Strategic and International Studies, told AP.

But launching a trade war runs the risk of a conflict spinning out of control. Nations can retaliate, which can spur more action on the other side. Given the high degree of political anxiety in the world these days over economic affairs, the hazards of protectionism seem higher than usual. History certainly offers little support for thinking that a nation can launch a trade war and contain the blowback while reaping the lion’s share of the game. It’s also a myth that trade wars can be fought on a limited scale, by targeting a particular ill or country. Surgical strikes simply don’t exist with protectionism, even on a small scale, in a globalized economy.

“Although a trade war may not be as destructive as a military warn, writes Randy Epping in The 21st Century Economy, in both cases many suffer–often the very people the war was meant to protect.”

In any case, it’s misleading to think that a stronger yuan is the cure-all for what ails the U.S. A tempting idea, but one with limited mileage. China’s export machine draws on more than a weak currency. Much more, as James Fallows explains in Postcards from Tomorrow Square: Reports from China.

Nonetheless, don’t underestimate the potential fallout from a trade war, or its apparent solutions. Yes, the Chinese currency is a problem for the global economy. Launching a new round of protectionism almost certainly isn’t the answer. The real challenge is coming up with policy responses that a) have a reasonable chance of success; and b) don’t end up causing more damage than the original problem. There are no easy answers, of course, which is what makes protectionism’s simplicity so appealing…and dangerous these days.

About James Picerno 894 Articles

James Picerno is a financial journalist who has been writing about finance and investment theory for more than twenty years. He writes for trade magazines read by financial professionals and financial advisers.

Over the years, he’s written for the Wall Street Journal, Barron’s, Bloomberg, Dow Jones, Reuters.

Visit: The Capital Spectator

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