Will the US Trade Deficit Spark a Currency War?

Will the US Trade Deficit Spark a Currency War?


If rising exports are going to lead the economy into a new era of prosperity as President Obama hopes, there isn’t much to cheer about. Last year’s trade numbers, which the Commerce Department released Friday, show exports are rising briskly, but the overall U.S. merchandise trade deficit soared to a record $558 billion.  That’s up 11.6 percent from 2010 as imports continued to rise even faster than exports.
The country-by-country breakdown confirmed what every shopper who reads product labels knows. China is responsible for more than half the total deficit, with its exports of $399 billion to the U.S. last year dwarfing the $104 billion in goods that the U.S. sent China’s way. Imports from China jumped $34 billion last year; exports to China rose only $12 billion.

That subject is certain to be on the agenda next week when President Obama meets with Chinese vice president Xi Jinping in Washington. The trade aspects of their talks will focus on China’s currency manipulation, which keeps the yuan (officially known as the renminbi) artificially low vis-à-vis the U.S. dollar to advance its export-led economic development strategy.
Currency jawboning is a long-standing Washington tradition, going back to the Reagan administration when the dramatic rise of Japanese imports triggered national teeth-gnashing about the declining power of domestic manufacturers. Treasury Secretary Geithner is an experienced practitioner of the art, and during previous bilateral visits with Chinese officials has consistently raised the issue.

And, to be fair, the yuan has gradually increased in value over the past 18 months, going from about 6.8 yuan to 6.3 yuan per dollar. But that’s an appreciation of less than 10 percent, not much different than the small declines in the dollar value vis-à-vis the Euro and the Japanese yen over the same period. It’s certainly not enough to make a major dent in the trade deficit. By the way, the U.S. ran $119 billion and $63 billion trade deficits with Europe and Japan, respectively, last year.
It’s easy to poke fun of Geithner and the Obama administration for their half-hearted attempts at jaw-boning the Chinese on currency values. In every possible venue, top Treasury officials over several decades, even as they complained about the world’s number one currency manipulator, simultaneously pledged their fealty to a strong dollar, and insisted it will remain the global reserve currency.

Never mind that currency chest-thumping is hardly required in a world where U.S. Treasuries remain the safe haven of choice and potential rivals – the Europe or yen – belong to economies in deeper trouble than the U.S. Surely Treasury officials recognize that the Chinese yuan cannot strengthen without the U.S. dollar simultaneously weakening. They are two sides of the same coin.


Of course, the Democrats don’t have a monopoly on logical inconsistency in the currency wars. The Republican Party’s on-again, off-again frontrunner Mitt Romney pledged during one debate that on his first day in office he would brand China a currency manipulator and slap countervailing duties on its imports unless it allows the yuan to float up. He then turned around and promised that he will “chart a course of fiscal responsibility that will guarantee a strong, stable dollar.” Clearly, when it comes to talking about currencies, flip-flopping is a bi-partisan affair.

Let’s face facts. The Chinese yuan is probably undervalued by 20 or 30 percent given its massive reserves of U.S. Treasuries. China is deliberately suppressing domestic consumption to spur exports. Until it reverses that policy, and allows its people to consume substantially more goods, it will not become a major importer of U.S.-made goods.

Is such a dramatic revaluation possible? In 1985, there was a major accord at the Plaza Hotel in New York between U.S. and Japanese central banking and Treasury officials that led to a rapid appreciation in the yen. Its goal: to reverse the yawning U.S.-Japan trade imbalance.

It didn’t really work. But over the next few years, it led the newly enriched Japanese holders of U.S. dollars to invest massive amounts in U.S. real estate. Do people remember the national reaction when Japanese investors bought Pebble Beach, the site of this weekend’s Professional Golf Association tournament event? How about Rockefeller Center in New York? Do people want to see that happen again? Never forget. When it comes to currency wars, there is always collateral damage.

The best policy for China’s currency is probably the long, slow appreciation path it is currently on. That will avoid the possibility of a sudden recession there, and unwanted side effects here.

What’s sad is that the focus on currency obscures the fact that there is no easy fix for the deeper problems facing U.S. exporters. When are we going to do something about the nation’s export infrastructure? It costs exporters three times as much to move a container of freight through Los Angeles as it does through Singapore.

When will Congress act on raising the limited amount of money targeted for Export-Import Bank financing? Its capacity is far smaller than what other nations offer their overseas export customers and is due to expire at the end of May because the reauthorization bill is hung up in a trade dispute. Domestic airlines like Delta and Southwest fear competition from Air India and don’t want that South Asian nation to use its guarantees to purchase Boeing jets. Meanwhile, U.S. businesses continue to move jobs abroad to take advantage of a tax code that encourages such behavior.
Fixing such problems would take bipartisan commitment to promoting exports and U.S. competitiveness. How much easier it is to sound tough on currency, especially as the campaign season heats up.