Monday, February 19, 2007

Senate Democrats take aim at China

In my January 19th post on the Weaponizing of Space, I wrote briefly about what democrats would do with regard to China and the weaponizing of space. From my knowledge, no resolutions were passed denouncing the action by congress. However, that doesn't mean China is off of their radar. Here’s what I wrote on 1/19/07.

The democrats are pissed! I worked for Sherrod Brown in the 2004 election campaign in northeast Ohio to support John Kerry. Even though I know him personally and can say with all certainty that he is a great, honorable and capable American, the freshman Senator from Ohio is going to have a field day with this with support of the protectionist, pro-labor side of the Democratic Party. The democrats need to look strong to their constituents on national defense and this is the perfect forum for that. I wonder what bills or resolutions will be passed on this issue.

Only 3 days ago, I read an interesting Opinion piece from USNews.com discussing possible legislation that will be introduced into the Senate by Sherrod Brown and fellow democrats that will change the status quo. The protectionists are definitely out in force.

Here is an excerpt of the article:

Also this week, Democratic Sens. Byron Dorgan of North Dakota and Sherrod Brown of Ohio, along with Republican Lindsey Graham of South Carolina, said they were introducing legislation that would strip China of its permanent normal trade status with the United States, subjecting the trade relationship to an annual review by Congress. Brown said in a statement:

U.S. trade policy has failed workers and small businesses across our country. As far as I am concerned, there is nothing normal about allowing our trading partners to use slave labor to compete with our workers. There is nothing normal about manipulating currency to make exports cheaper. There is nothing normal about mouthing concern for intellectual property in the midst of rampant piracy. And if this is indeed normal, then I certainly don't want it to be permanent.

Who knows what will come of this. The last time something like this happened was in 2005 when NY Senator Chuck Schumer tried to introduce a 27.5% tariff on all Chinese imports. That was pushed aside due to talks between Sen. Schumer, and the current Treasury Secretary, Henry Paulson. Hopefully someone will have the same influence this time.

In a Chinese perspective, it seems that these senators are kind of ignorant. They are looking past the other obvious problems with the US economy that includes spending billions and billions on the war in Iraq while simultaneously giving the richest in the US a tax break, deficit spending, and de-taxing and de-regulation of corporations which have been profiting handsomely from these policies. Instead, they point to one thing. The increasing trade deficit with China and the need for a quicker appreciation of the yuan. Here’s what the USNews.com article predicted (as a lot of economists says) what would happen if China followed through.

In the 1980s, just as with China today, many in the United States were pushing Japan to strengthen its currency. How did that work out for Japan? As Will Hutton, China expert and author of the book The Writing on the Wall: Why We Must Embrace China as a Partner or Face It as an Enemy, told me in an interview late last year:

The more than 50 percent rise in the yen in the late 1980s was the single most important cause of Japan's near 15 years of economic stagnation that followed; if the yuan went up by 40 percent suddenly against the dollar, it would have a similarly devastating impact on China. . . . Such a rapid appreciation of the yuan over a short period could be a tipping point for a wave of unrest, which could threaten the regime's stability. The party leadership sees the demand for fast yuan appreciation as an act of economic warfare. In these terms, you can see why.

And would troubles in China affect America? Here is the scenario that Hutton sees:

China's stagnation would trigger a global slowdown, maybe even recession. ... The World Bank estimates that if China's growth rate fell by just 2 percent, up to 60 percent of China's bank loans would become nonperforming–so threatening both China's and, via Hong Kong, Asia's financial system. The flow of saving to finance the U.S.'s deficit would dry up, probably forcing U.S. interest rates up–so worsening the economic slowdown.

A scary scenario, no doubt–and one both Democrats and Republicans should do their best to avoid.

I would agree.

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Anonymous said...

"The more than 50 percent rise in the yen in the late 1980s was the single most important cause of Japan's near 15 years of economic stagnation that followed; ..."

As an engineer fluent in Japanese, associated with the country in various ways for over 30 years, about eight of them as a resident in the country, I can't agree.

The real problem was Japan's failure to open its economy and demand that it get its money's worth for its exports at that point in time (late '70s) when a negative balance of payments was no longer a concern. As a result, it continued to build excess capacity for export goods production, and never developed a fully balanced economy.

The theory of comparative advantage implicitly assumes that exchange rates are such that prices properly value the production inputs in the trading countries. When the exchange rates are manipulated, prices send false signals about which nation has true comparative advantage in which areas, and so causes suboptimal allocation of resources.

Over the decades, the Japanese have sent well over a trillion dollars worth of useful products to the US and accepted in return dollars whose real buying power is much less. One often sees articles stating that if the dollar falls they will suffer a loss, but in fact they suffered the loss when they accepted the dollars in exchange -- all that's being delayed is a formal recognition of that loss.

What the Japanese power elite is doing is a form of vendor financing fraud. Like Nortel and Lucent in the telecoms bubble years, they are lending customers the money to buy their products, ignoring their ability to repay; as long as the managements of Nortel and Lucent were able to continue that, they looked like geniuses and raked in the dough. But there were accountants to, well, call them to account. In the case of the Asian governments, there is no one (except a few economic commentators) to call them to account, so ti's hard to tell how long they'll be able to continue the fraud.

Another way to understand what is going on is to imagine what the situation of the Detroit automakers' top management would be if they could take the Midwest out of the Union and create their own "Detroit dollar" currency pricing Midwesterner labor at a fraction of its true value. Midwestern exports would soar, unemployment would plummet, and they'd appear very successful, but Midwestern living standards would end up below where they would be in a free-trade regime.

If one matches the living standards of Americans and Japanese of equal ability putting out equal effort in their careers, you'll almost always find the American having a much higher standard of living. On average, Japanese are more able and harder-working than Americans -- why don't they live as well? It's no longer because they don't have comparable natural resources -- the US imports most of its materials, too.

Mercantilist exchange rate manipulation creates a (barely) hidden subsidy for export manufacturers. Subsidies distort and lead to suboptimal resource allocation, and to the building of capacity that then cannot be sustained if the subsidies are removed. That is the reason for Japan's economic doldrums -- the longer they subsidized unprofitable industries and distorted their economy the more difficult it became to abandon the subsidies. Ponder the fact that a large fraction of China's trade surplus is in fact a disguised Japanese trade surplus (high-value-added Japanese components sent to China for assembly and final export to the US); if it were not for this, the outrageous undervaluation of Chinese labor by current exchange rates would have led to Japan having a much larger trade deficit with China.

I strongly recommend Richard Koo's "Balance Sheet Recession", in which he discusses some of the ways Japan's failure to develop a balanced modern economy have exacerbated its problems.

The longer China goes without allowing its currency to adjust to reflect the true value of it's citizen's labor, the more it will lose, and the more difficult it will become to build an economy that can function without the currency subsidy.

jm

P.S. Have really enjoyed reading your posts.

2/20/2007 11:24 PM

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