Thursday, May 29, 2008

Heritage Foundation think tank goes brain dead on China currency manipulations

In a policy paper, posted on the Heritage Foundation’s website, Ambassador Terry Miller, Director of their Center for International Trade and Economics, came out strongly against the Chinese Currency Manipulation Act of 2008, a bill that would combat the Chinese currency manipulations that put American products at a disadvantage when competing with Chinese products. Here are some selections from his paper, followed by my comments:

Contrary to the expressed goals of the sponsors, such measures are unlikely to stop the loss of manufacturing employment in the United States, or hurt the Chinese.

Miller is simply wrong here. The Chinese mercantilist economic policy is to export as much as possible to the United States while minimizing the amount that they import from the United States. They use their currency manipulations to do so. The result has been the loss of industry after industry to China.

The bill that Miller is denigrating is designed to end Chinese currency manipulations. It would not actually do so, but if the currency manipulations were ended, the Chinese currency would rise to the price that would cause trade between the two countries to be balanced. As a result the Chinese labor costs would rise tremendously as compared to American labor costs and China would be forced to import from the United States, so they would eliminate their tariffs on Michigan auto parts, Harley Davidson motorcycles, and Bucyrus mining machinery. American products that compete with Chinese products, such as Whirlpool appliances, would become more profitable and expand production. The result would add millions of manufacturing jobs to the American economy.

If he is talking about the Chinese people, Miller is wrong that the bill would hurt the Chinese. It would raise their relative wages compared to wages in other countries, making imports much less expensive to them. It would also force the Chinese government to loan hundreds of billions of dollars worth of renminbi to the Chinese people, instead of using those renminbi to buy dollars and then loaning the dollars to Americans. The result of these changes would be that credit would become available to the Chinese middle class, and there would be an immediate rise in living standards in China.

However if Miller is talking about the effect of the bill upon the Communist government of China, he is correct. If the Chinese government were to eliminate their currency manipulations, the middle class in China would be strengthened and Communist control would indeed be weakened. Miller continues:

Their primary effect would be to spur inflation and hurt American consumers.

Miller is correct that the bill would result in higher prices for Chinese-made products. On the other hand it would help American workers compete in the international marketplace because their wages would be more competitive with the substantially increased Chinese wages and also because American companies would invest in more efficient factories in order to expand US production.

As far as inflation is concerned, the result is debatable. Inflation is largely a monetary phenomena. The Chinese loans to the United States are making it impossible for the Federal Reserve to control inflation without holding short-term interest rates higher than long-term interest rates (what economists call an "inversion"). The Fed would actually have better control over inflation if it weren’t for the huge Chinese loans to the United States that are a byproduct of Chinese currency manipulations. Later he writes:

It is true that China's exports to the United States have risen rapidly over the last decade, too. However, that surge appears to have come at the expense of other Asian exporters, not U.S. manufacturers. In 1995, China and Japan together accounted for 23 percent of U.S. imports. In 2005, China and Japan together still accounted for 23 percent of U.S. imports. What changed was that in 1995, Japan accounted for 73 percent of those combined imports and China only 27 percent; by 2005, China's share had grown to 64 percent and Japan's had fallen to 36 percent.[8]

Miller is using the wrong statistic. In order to determine the extent that Chinese and Japanese currency manipulations have hurt United States manufacturing, it is necessary to consider imports as well as exports. The simple statistic to consider is the Chinese and Japanese combined trade surpluses with the United States. After all, the goal of their currency manipulations is to increase their trade surpluses with the United States. The following graph shows that the combined Japanese and Chinese trade surplus with the United States accounted for 0.9% of our GDP in 1996 and 2.5% of our GDP in 2007. In other words, since 1996, Chinese and Japanese currency manipulations have stolen the US manufacturing industries that would otherwise be producing 1.6% of our GDP.


Miller’s next argument shows that he is completely out-of-touch:

Assuming, for the sake of argument, that the renminbi is undervalued compared to the dollar, the question is whether this is as bad for Americans as politicians assert. It's true that a U.S. producer of a product that is in demand in China will normally sell more in China if the renminbi appreciates against the dollar. Similarly, a U.S. producer of goods for domestic consumption competing against Chinese imports will also normally sell more if the renminbi appreciates.

There aren't very many such firms, however. Chinese and Americans don't generally produce the same things. Indeed, it is through specialization, not competition, that both countries reap the benefits of trade. As noted above, Chinese exporters to the U.S. compete with other Asian economies for market share in the U.S. American firms compete with Europeans, Japanese, and Asians for market share in China. Changing the renminbi/dollar exchange rate will not significantly affect those trade flows.

Is Miller unaware of the fact that the Chinese just built three factories to produce the heavy mining equipment produced by Bucyrus and other American companies, while slapping a 40% tariff on Bucyrus mining equipment. Is he unaware of the Chinese have a 30% tariff on US cars, on US autoparts, and Harley Davidson motorcycles, while they build their own vehicle industries. Is he unaware that the Chinese are about to buy GE’s appliance business and then move those 300,000 jobs to China, leaving Whirlpool as the only remaining US appliance producer. He clearly doesn’t understand the mercantilist strategy of exporting, but not importing so that they can steal US industries. He continues:

Changing the exchange rate will, however, affect U.S. producers who use intermediate goods imported from China in their U.S. production processes. Renminbi appreciation will increase their costs of production. U.S. consumers of basic commodities like oil will also be hurt, as renminbi appreciation will make dollar-denominated commodities like oil cheaper for the Chinese. Chinese demand, already rising rapidly, will drive up the dollar price of such commodities worldwide, forcing American consumers to pay even more at the pump.

This particular quote is essentially correct, but tells only a small part of the story. Another part of this equation is that a change in the relative currency values will make US intermediate products, such as auto parts made in Michigan, less expensive to Chinese industries. Also, the continuing trade deficits caused by our loss of industries to the Asian mercantilists, are the real cause of the dollar’s slide. In the long run, if we continue to lose our industries, we will not be able to afford to import oil and other commodities. You need exports to import. Allowing these currency manipulations, as Miller would do, causes the United States to lose industry after industry, making the dollar ever more precarious. Miller is engaging in very short-term thinking regarding the price of commodities here. He continues with one final argument:

We get … more investment capital to help our economy grow and keep our unemployment rate low.

Currently the United States is getting so much unwanted investment capital flowing in from foreign governments who are manipulating exchange rates that the US long-term interest on US Treasury 10-year notes is less than zero, after subtracting inflation. The fact is that the United States will get little investment by our manufacturing industries, no matter how low the interest rate, until manufacturers realize that we are serious about balancing trade.

In the final analysis, Ambassador Miller is saying three things:
  1. The Heritage Foundation favors American consumers more than American producers.
  2. The Heritage Foundation thinks that US policy should support the Communist government in China.
  3. The Heritage Foundation favors lower interest rates, even when real interest rates are negative.
It is truly a shame when a think tank goes brain dead. Follow the following link to read Ambassador Miller’s policy paper on the Heritage Foundation’s website: http://www.heritage.org/research/TradeandForeignAid/wm1919.cfm

Howard