Thursday, August 9, 2007

Chinese Train Crash and the Rest of the World

As US Treasury Secretary Hank Paulson ends yet another round of Strategic Economic Dialogue talks in Beijing with very little progress to show for his efforts, one cannot help feeling that one is watching a slowly unfolding Greek tragedy. For all the main protagonists of this drama play their parts seemingly oblivious to the very unhappy end towards which their actions are inexorably leading them. And they certainly pay no heed to the growing chorus of Cassandras warning of the grave dangers to the global trade system that lie ahead.

Among the leading protagonists in this drama are Chinese President Hu Jinato and Vice Premier Wu Yi, who represent the Chinese Communist Party in these talks. Filled with hubris, they never seem to tire of reminding Mr. Paulson of China's 5,000-year glorious imperial past. Nor do they tire of making it quite clear that a country of China's historic importance is not about to change its exchange rate policy under pressure from the United States, a relative newcomer on the international stage. Rather, they insist that the Chinese government will set its exchange rate policy exclusively in China's own national economic interest.

The Chinese also make it quite clear by their actions, if not by their words, that they view China's economic interest as that of maintaining an artificially undervalued exchange rate. They do so with a view to allowing China's exports to grow each year by a staggering 30 percent, which they see as the only realistic way that the Chinese economy can absorb the 10 million workers who leave the Chinese countryside for the cities each year.

For his part, Secretary Paulson consistently seems to allow hope to triumph over experience in maintaining his belief that China will revalue its currency on its own accord in an effort to reduce its ballooning trade surplus with the United States. He also never seems to tire of counseling Congress to be patient in its dealings with China on the exchange rate issue.

In adopting his softly-softly approach towards the Chinese, Mr. Paulson seems to ignore the fact that over the past two years China has egregiously failed to deliver on the promises that it made to the United States in June 2005 to become progressively more flexible on the exchange rate issue. Indeed, over the past two years, China has allowed only the minimum of appreciations of its currency against the depreciating US dollar, while on a trade-weighted basis China's currency is as grossly undervalued today as it was in June 2005.

While Mr. Paulson urges patience and while he steadfastly refuses to deem China a currency manipulator, China's trade surplus with the United States continues to grow like Topsy. In the first six months of 2007 alone, China's trade surplus with the United States swelled to a record US$112 billion, which was a full 85 percent greater than China's surplus in the same period of 2006.

True to script, the US Congress is adopting an increasingly confrontational stance towards China with the approach of the 2008 elections growing nearer every day. It does so knowing full well that China bashing is a sure vote getter at a time of increased economic insecurity. As the US economy slows under the weight of its severe housing market slump, external scapegoats like China always come in handy.

Seemingly forgetful of the disastrous consequences for global prosperity of the 1930 Smoot-Hawley Tariff Act, today Congress has before it no fewer than 60 proposals to do something about the Chinese trade surplus. More ominous still, last week the Senate Finance Committee approved a proposal that would require the US Treasury to impose anti-dumping duties on China should China persist in maintaining an undervalued exchange rate. And the Committee did so with a 20 to 1 majority, which should be seen by China as the clearest of warnings that Congress could very well approve veto-proof trade legislation that would be inimical to China's longer-term economic interest.

For its part, the International Monetary Fund, whose supposed role in this looming US-China showdown is that of acting as international umpire, also sticks unswervingly to script by maintaining a deafening silence on the Chinese exchange rate issue. Still smarting from its loss of credibility in Asia for its mishandling of the 1997 Asian currency crisis, the IMF lacks the backbone to declare that China's currency is grossly undervalued and to call upon China to do something about its undervalued currency.

There is of course always the chance that China blinks in time and takes substantive exchange rate action that might avert a breakdown in US-China trade relations. However, all the clues are currently pointing in the direction of China not budging from its present policy script. At a time of increased global financial market volatility, this is a great pity as it is certainly the last thing that the world economy now needs.

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