July 26, 2005,
The Wall Street Journal’s Greg Ip lauded China’s decision last week to partially delink the yuan from the dollar. Ip surmised that the action would move “the global economy closer toward balance,” and for potentially making Chinese goods more expensive to U.S. consumers, would cause the “the U.S. to import less,” and as a result reduce “the trade deficit [that] has risen to record levels.” Ip’s reasoning defies recent history, and simple economics too.
Nearly 20 years ago, the U.S. political and media elite were spooked by another rising economic power Japan. Just as senators Lindsey Graham and Chuck Schumer threaten China with tariffs today, representatives Richard Gephardt and Dan Rostenkowski had a bill on the House floor that would restrict “imports from countries defined as having ‘excessive trade surpluses’ with the United States.”
The response to the rising economic nativism in the U.S. was the 1985 Plaza Accord, in which the G-5 countries agreed to an “orderly appreciation of the main non-dollar currencies against the dollar.” What the plan really meant was that to save the world from an even more blatantly protectionist U.S. response to competition, Japan would have to substantially deflate its currency as a penalty for providing U.S. citizens with the high-quality goods they desired.
From September 1985 (Plaza) to February of 1987 (Louvre Accord), the Japanese yen rose 36.5 percent versus the dollar, thus setting in motion the deflation that helped send Japan into an economic funk that it is only now recovering from. Though 2 percent (the yuan’s initial rise versus the dollar) is far short of 36.5 percent, to concentrate on how much the yuan has risen so far is to miss the point entirely.
Indeed, conventional wisdom 20 years ago argued that a weaker dollar would reduce Japan’s trade surplus with the U.S., and along the lines of Ip’s thinking, push the “global economy closer toward balance.” The “experts” in the ’80s hadn’t done their homework. Just as major dollar devaluation in the 1970s failed to reduce our trade deficit, the deflation forced on Japan in 1985 similarly failed to reduce our trade “imbalance,” though U.S. stocks and bonds did decline, with stocks ultimately crashing in October of 1987, the Monday after Treasury Secretary James Baker talked down the dollar on the Sunday morning talk shows.
Returning to the 2 percent revaluation, talk is that it isn’t very much. But when 10 and 20 percent upward revaluations similarly fail to cure the U.S. trade deficit “problem,” what’s to say that Schumer and Graham won’t introduce another tariff bill? That, or China could be forced to deflate more. Has the political class studied how a militarily ambitious China might respond to a recession?
The shame here is that U.S. and world economic policy continue to be held hostage by elite obsession with the trade deficit. Robert Bartley once asked “why we even collect these figures,” given that all trade logically must balance. The answer to today’s trade deficit of course has to do with American desire for goods not in our economic self-interest to make. The “deficit” is the logical result of those desires, in that all those dollars flowing overseas must eventually return to the U.S. Happily, they return in the form of investment (not counted in trade figures). Just as we like foreign consumer items, foreigners have an insatiable appetite for U.S. equities and land, along with our public and private debt.
Importantly, the perceived Chinese export advantage that has trade-deficit worriers so spooked accrues to the U.S. consumer. Assuming revaluation succeeds in making Chinese exports more expensive, the broad American population will lose twice: first in seeing their buying power reduced, and second in the necessary loss of productivity that always results when nations don’t take advantage of the economy-boosting division of labor. Those who doubt the latter point need only study the relative employment rates of countries with open versus closed markets.
U.S. Treasury Secretary John Snow described as “extremely positive” last week’s currency move by China. While China’s new linkage to a “basket” of currencies still carries with it a very strong dollar link, Snow still gets it backwards. Currency revaluations forced on China by the U.S. are explicitly protectionist, and for being protectionist they will weigh negatively on future economic growth.
Worse, as the world’s foremost economic power, the U.S. should welcome the chance to set an example for other countries that aspire to be rich like us. The U.S. political class simply must not cave in to special-interest pressures and force on China and its own citizens nonsensical economic cures that have consistently failed throughout history to create the very jobs and growth so essential to prosperity.
John Tamny is a writer in Washington, D.C. He can be contacted at email@example.com.