A few days ago,China threatened to offload its Billions of US Treasuries in retaliation to any US imposed trade tariffs.
One of the newsletters I read regularly is from John Mauldin who doesn’t think its likely that China will follow through with their threat.
China has an estimated $900 billion in US dollar reserves. There is no doubt that if they did decide to sell a few hundred billion here or there, they could push the dollar down against all currencies and not just the renminbi. That would also have the effect of increasing US interest rates on not just government bonds, but mortgages, car loans and all sorts of consumer credit.
Given the current state of the credit markets, that is not something that would be welcome. But it is not likely for several reasons. First, it is not in their best interests to do so. It would hurt the Chinese as much as the US, as it would devalue their entire dollar portfolio and clearly do damage to their number one export market – the US consumer.
Secondly, it is unlikely that the US will actually be able to get such legislation passed into law. Even if such legislation passed Congress (an admitted possibility) it would be vetoed by President Bush. That means that any real change would not be possible until some time in the middle of 2009.
The renminbi has already increased almost 10% in the last two years since the Chinese started their policy of a crawling peg. For reasons I outlined at length a few weeks ago, it is likely that the Chinese are going to increase that pace over the next two years, for their own internal reasons. A higher renminbi valuation helps them slow their economy down from its way too fast pace of growth that is evident today. (If you would like to see that analysis, click here.)
By the time any real legislation could get passed, the renminbi will be very close to the level where the China bashers in Congress want to see it, if it is not already floating. Hardly enough to want to start a trade war at that time.
But let’s look at what the bi-partisan economic illiterates in Congress are actually advocating. First, they whine about lost American jobs. But a 25% higher renminbi is not going to bring any manufacturing jobs back. China is no longer the low cost labor market. There are other Asian countries with lower labor costs. We just will not be able to competitively manufacture products that have high unskilled labor costs.
But we will continue to manufacture high value added items in a host of industries where skill and talent are required. Even though manufacturing as a percentage of US GDP is down, our actual level of exports and manufactured products is up by any measure. It is easy to write about the closing of a plant, and it makes the headlines, but the fact is that free trade has created more jobs by far than we have lost.
Secondly, if our cost of imports were to rise by 20-25%, that cannot be understood as anything but inflationary. And it would not just be Chinese products, but the products of all developing countries. Many Asian countries manage (manipulate) their currencies to keep them competitive against each other and the Chinese. You can bet that if the renminbi rises another 20%, there is the real prospect that they all will.
And much of what China and the rest of Asia produces is bought by those on the lower economic rungs of the US ladder. So, if Congress gets its way, they would be advocating putting pressure on those least capable of paying higher prices. But no one lobbies for the little guy. Congressional members can pander to their local unions and businesses without having to answer for what would be higher prices.
And higher prices means more inflation which means that interest rates have to be higher than they should, which means higher mortgage rates, etc. Protectionism has a very high cost. Free markets create more jobs everywhere.
Finally, we should hope the Chinese continue to allow their currency to rise slow and steady. Neither country needs the turmoil a rapid rise would induce. The world needs a stable China. We are watching world credits markets freeze up because things went very bad very quickly in the relatively small subprime world. A 20% drop in the dollar in a few months would be even more catastrophic. Senators Lindsey Graham and Chuck Schumer are competing to be this century’s Smoot and Hawley that creates a depression from trade wars where none should be.
The danger in all this is that politicians who have little economic literacy create a hostile environment with their rhetorical poison, with both sides feeling the need to play to their “home crowd.” That is a very dangerous environment.
It won’t happen, but I would like to see the following question asked in the presidential debates to those (like Hillary Clinton, Obama and Dodd, etc.) who basically advocate a weaker dollar.
“Why are you advocating a weak dollar policy? Why do you want American wage earners to pay 25% more for the goods we buy from foreign countries? Do you really think there is no connection between the value of the Chinese currency and the rest of the currencies of the world? Do you think American consumers need to send even more money overseas and get less for our dollars? Do you think the American consumer is so well off they can afford to pay more and that it will have no affect on the US economy? Do you realize that a 25% lower dollar will mean a rise in world oil prices? Do you think there is no connection between the value of the dollar and US prosperity?”