Another Reason for an Intelligent China Policy

Another Reason for an Intelligent China Policy

Freedenberg

The Bush Administration’s failure to deal aggressively with China’s unfair trade and currency policy has contributed to the credit crisis that the world is experiencing today.

That is a controversial assertion. But let’s discuss some recent history.

For the past five years, AMT has been advocating changes in our China trade and currency policy. As a part of a coalition led by the National Association of Manufacturers, AMT advocated a more aggressive China trade and currency policy. We urged the Bush Administration to press China on the issue of its misaligned currency.

We were part of a coalition that filed a petition three years ago, under Section 301 of the Trade Act of 1974. That petition argued that it was a violation of World Trade Organization rules for China to refuse to adjust its currency -- the yuan -- upwards, or alternatively to allow the yuan to float — even in a managed fashion — in the world’s currency market.

The Administration promptly rejected our petition, but within a year, perhaps in response to U.S. domestic and Congressional pressure, China began a limited — and insufficient — effort that allowed the yuan to slowly appreciate. For the first time, the yuan began to reflect China’s new competitive position as one of the world’s leading manufacturing and trading powers.

Since then, the yuan has appreciated, but most international trade experts agree that it is still significantly undervalued – by as much as 20 percent – and that this undervaluation is continuing to give China an unfair advantage in international trade.

More importantly, however, in order to keep the yuan undervalued China has been intervening heavily in international currency markets, inducing other Asian governments, such as Japan and Korea, to do likewise in order to keep their competitive positions.

Too late, Treasury Secretary Henry Paulson has opened a “Strategic Dialog” with China concerning their currency and other trade problems. China agrees that it needs to do more and seems to accept expert advice from the U.S. Treasury, but it is “slow-walking” its reforms and adjusting its currency at far too measured a pace to satisfy the world community.

As part of its strategy, China intervened with hundreds of billions of dollars per year in world currency markets to buy Treasury bonds and U.S. dollar instruments. Among those instruments were hundreds of billions of dollars worth of Fannie Mae and Freddie Mac bonds, thus creating hyperliquidity in the U.S. housing market.

With the implicit backing of the U.S. Government, those bonds had a substantially higher yield than plain old Treasury bonds. China was not alone in this enterprise, but the result was to create a situation where far too much money was chasing increasingly lower quality assets.

The Bush Administration and the Federal Reserve have reacted aggressively to the financial meltdown. It would have been far better if they had reacted anywhere near as aggressively at the beginning of the decade, when the Chinese had begun their massive intervention in the currency markets that added to the flood of hyper-liquidity.

Most likely, our experience with hyper-liquidity will not lead to the stagnation and credit crunch that took Japan in the 1990s from high growth to low growth for 15 years after their bout with hyper-liquidity.

But we are now faced with the problem of how to best come down from a bubble economy. The easy credit led to not just a housing bubble. We have too many office buildings, shopping centers, and hotels, not to speak of all the other things that are purchased when credit is overly loose.

It will be the next President’s problem to navigate through these perilous economic waters.

Hopefully, he will recognize that domestic and international economic policy cannot be separated, that neither can be ignored without grave danger to overall economic order.

Protectionism is not an answer. But neither is an attitude that fails to react to deleterious trade and currency policy of a major trading partner.

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