China and the World, Talking Point

The Senate’s scapegoat?

New US bill could label China a currency manipulator with dire results

The Senate’s scapegoat?

Facing off: the exchange rate of the Chinese renminbi has become a political hotcake in the US once again

“So disgusting, so dirty and vile that the reading of one page was enough for me… It is most damnable! It is written by a man with a diseased mind and a soul so black that he would obscure even the darkness of hell!”

It doesn’t sound like DH Lawrence’s Lady Chatterley’s Lover was ever going to be bedtime reading for Reed Smoot, US senator for Utah, who led calls in March 1930 for a ban on the import of obscene literature.

The campaign generated plenty of media attention (“Smoot Smites Smut” was one headline), with the Kama Sutra, Casanova’s memoirs and even verse from Scottish poet Robbie Burns also on his hit list.

But it was for a different piece of legislation aimed at curtailing imports – the Smoot-Hawley Act of the same year – that the senator is now best-remembered. And he is now getting mention again, as the US Congress considers a new piece of currency legislation that could also lead to a major trade confrontation, this time with the Chinese.

The story so far…

The US Senate has voted in support of a new bill proposing tariffs on countries that purposely undervalue their currency.

China isn’t mentioned by name but there’s no doubt that it is the main target of the Currency Exchange Rate Oversight Reform Act, which is co-authored by Democrat senator and longtime China critic, Chuck Schumer.

Most analysts agree that China would take any US tariff action immediately to the World Trade Organisation. But the damage would already have been done, they say. Tariffs would have been imposed in the period leading up to any WTO ruling, and the Chinese can be expected to respond with countermeasures.

The fear is that global trade will take a damaging hit at a time when sentiment is already fragile.

Is the legislation going to pass?

Talk of wider trade war between Beijing and Washington isn’t new, and has flared up repeatedly during narrower spats in the past. Try WiC31 (for tyres), WiC44 (for steel pipe) and WiC41 (for chicken feet).

Similarly, tensions over the Chinese currency have also come in for regular comment since the first edition of WiC in February 2009.

Back then it was presidential candidate Obama playing the tough guy, with a plan to look the Chinese straight in the eye as he warned them to change their ways. “If you guys keep on manipulating your currency, we are going to start shutting off access to some of our markets” was the message he said he was going to deliver.

Obama as president hasn’t gone through with the threat. In fact, as Bob Davis at the Wall Street Journal points out, no administration since Clinton’s in 1994 has actually tagged China as a currency manipulator. Last Friday the Treasury Department again postponed a decision to label China as such. Nor has the White House ever taken the next step of imposing duties on China because of currency malpractice.

This time is different?

House Speaker (and Republican) John Boehner has said that he will seek to block the bill (a “dangerous” proposal) from reaching the House of Representatives. But unusually, he is starting to come under more pressure from his own side to support the legislation. Republicans have traditionally rallied in support of freer trade but they now seem more divided, and 16 of their party backed the Schumer proposals.

Nor does Boehner seem to want to go out ahead of the crowd in quashing the bill, instead calling for Obama himself to indicate whether he will veto it.

“It’d be nice for the president of the United States to make clear what his position is,” he has told reporters. “It’s time for the president to lead.”

If the bill did progress this time, it would put Obama very much on the spot to veto the proposals.

Why the push now?

In part because the bill’s sponsors want to feed on American frustration at its economic malaise, says Michael Cohen at Foreign Policy magazine. Also, tough times often end up in the search for a scapegoat, Cohen says. Here he sees comparisons with the months following the Wall Street Crash of 1929, when Congress passed the Smoot-Hawley Act (Smoot and Hawley were both Republicans, as it happens).

The legislation – which started out as a minor bill to appease farmers hit by falling commodity prices – developed into a protectionist free-for-all, as interest groups pressured lawmakers into topping-up tariffs on thousands of foreign goods.

The result was international fury. America’s trading partners (with Canada at the forefront) struck back with a series of retaliatory measures. Global trade dropped sharply and American exports were seriously hit.

Xinhua also did its best to dust off the history books this month and make the link to Smoot-Hawley days.

“Comparing the current political and social situation with that of 80 years ago, we can find stark similarities: an economic downturn, a high unemployment rate, marked popular discontent and growing political conflicts, especially when presidential politics is getting hot,” the state news agency warned.

Ah yes, the politics…

As we also wrote last year (WiC88) the China-as-villain theme tends to become more prominent during certain phases of the US political cycle.

In a single week of campaigning for the US midterms last December, 29 candidates ran advertisements suggesting that their opponents were too sympathetic to China, and that as a result Americans were suffering. And this autumn the rhetoric is being stepped up once again, although this time it is Republican presidential front-runner Mitt Romney making much of the early pace.

“Day one, I will issue an executive order identifying China as a currency manipulator,” Romney announced in a debate last week. “People who have looked at this in the past have been played like a fiddle by the Chinese. And the Chinese are smiling all the way to the bank, taking our currency and taking our jobs and taking a lot of our future.”

Romney is shaping up to be one of the more outspoken presidential candidates when it comes to China relations. “If you are not willing to stand up to China, you are going to get run over by China,” he also warned.

Of course, Beijing’s policymakers do not need to play to the electoral crowd in quite the same way as their Washington counterparts, although they still have a political constituency that they need to impress, including wider public opinion.

And as the mood begins to polarise, being perceived as too pro-American becomes more of a weakness. For example, Cheng Li, a Brookings Institution China scholar, told the Wall Street Journal recently that the threats emanating from Washington have harmed the prospects of Vice Premier Wang Qishan, who pundits reckoned to have an outside shot at getting the number two slot in the government next year. Wang has been more prominent than others in calling for China to rely more on domestic consumption than exports – a position that dovetails with Washington’s pressing for a stronger yuan. But as the terms of the debate grow more emotive, it becomes a more difficult argument to make publicly – as it looks to Chinese eyes like a capitulation to the American view.

So does the US public back action over China’s currency?

No one seems to know for sure how far support would extend. Commentators wonder how long American consumers would stay behind tariff action once the repercussions began to be felt in their wallets. In 2010, the US imported $365 billion worth of goods from China, and critics of the bill say it could put up import prices by 20%-30%. That could add up to Americans being as much as $100 billion out of pocket.

US corporate bosses – especially at larger multinationals with China operations – are also perturbed, and warn of major upheaval should the legislation pass.

The China Daily reported on a letter sent in late September to Senate leaders by 51 business and industry organisations, warning that “unilateral legislation on this issue would be counterproductive not only to the goals related to China’s exchange rate that we all share, but also to our nation’s broader objectives of addressing the many and growing challenges that we face in China.”

There were similar warnings in 1930, when President Herbert Hoover received a petition from more than a thousand US economists urging him not to sign the Smoot-Hawley bill.

“Countries cannot permanently buy from us unless they are permitted to sell to us,’’ the economists explained, “and the more we restrict the importation of goods from them by means of even higher tariffs, the more we reduce the possibility of our exporting to them.’’

Some do back the bill, though?

Labour unions and domestic manufacturers in the US have been calling for action for years, arguing that an undervalued yuan gives Chinese competitors an unfair advantage (see WiC82 for an overview of the debate).

But there are convincing counter-arguments. There is plenty of evidence of the trade deficit widening, even as the yuan has strengthened, implying that there are factors other than currency involved. Over the past five years the yuan has appreciated 20% against the dollar. But in August, China’s trade surplus with the US hit a monthly record of $29 billion.

Also significantly, the trade numbers overstate Chinese success. Apple products are often used as the example. Each iPad sold in the United States adds as much as $275 to China’s trade surplus but the value actually captured by the Chinese economy is much smaller – only about $10 or so of processing cost of putting each product together.

In an age of globalised supply chains, the data fails to reflect a more complicated reality. And something similar applies to the claims that the currency bill will protect American jobs. Not so. Even if the prices of Chinese goods go up, many will be replaced by alternatives made in countries like Vietnam and Bangladesh – and not in factories in the US. Indeed, a criticism being made of the currency bill in general is that it deliberately over-simplifies a hugely complex issue, especially in choosing to overlook the new interdependency of the global economy.

Back in the days of Smoot-Hawley, the US was not nearly as open to international trade, with total imports a small fraction of gross domestic product. But today, the situation is very different, and that raises the stakes on any confrontation between the Americans and the Chinese, as well as for the rest of the global economy. If cooler heads fail to prevail and both sides do resort to a trade war, the consequences will be serious.

© ChinTell Ltd. All rights reserved.

Sponsored by HSBC.

The Week in China website and the weekly magazine publications are owned and maintained by ChinTell Limited, Hong Kong. Neither HSBC nor any member of the HSBC group of companies ("HSBC") endorses the contents and/or is involved in selecting, creating or editing the contents of the Week in China website or the Week in China magazine. The views expressed in these publications are solely the views of ChinTell Limited and do not necessarily reflect the views or investment ideas of HSBC. No responsibility will therefore be assumed by HSBC for the contents of these publications or for the errors or omissions therein.