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Trade War, Trade Law

October 17, 2011 8 comments

Last week the US Senate passed the Currency Bill, which calls for the U.S. government to impose tariff sanctions against countries that manipulate their currencies. Of course, the currency on their minds is the Chinese yuan, and probably with good reason. Over the past decade, the United States has had an enormous trade deficit with China, and last year the deficit figure was $273 billion, the largest ever (see the stats). The ever-growing imbalances between the two have persisted into this year, and the yearly deficit has now reached $290 billion.

Besides the fact that the United States itself was a “currency manipulator” when the Fed pumped $600 billion into the economy, thereby deliberately weakening the dollar (in recent years, the US dollar index has been the lowest since 1973, see the figure on the left), the Senate’s effort to solve the problem will merely risk a trade war, in which both sides exchange retaliatory measures only to hurt themselves. First, the yuan has increased by 30% in nominal terms since 2005, and yet America’s deficit with China has widened (see the figure on the right). Second, “adjustment” or “re-balancing” has already been under way, albeit at a snail’s pace, and will continue without anybody having to launch a mutually destructive trade war. Chinese unit labor costs have been growing fast at about 8.5% annually, rapidly catching up to the more well-to-do countries. This means that the rate of the yuan appreciation against the dollar in real terms has been and will be quite high, about 15% per year (see here). It also means some of the manufacturing jobs America has lost to China might come back sooner or later. Indeed, this “re-shoring” has already happened in some sectors according to the Boston Consulting Group (see here).

This doesn’t mean that the United States cannot or should not do anything in the mean time. For instance, the American solar panel industry has been severely hurt by a near overtake of the industry by Chinese competitors fed and nurtured by massive Chinese government subsidies, which may well be a violation of WTO trade law. The well-known failure of Solyndra is just one of the many victims of nearly 200 Chinese subsidy programs. The Obama administration has taken some steps to bring this issue to the WTO, the right place to go (see here). So it’s law, not war, that should govern international trade. (The irony is that to curb climate change and save the earth, probably we need to urge, rather than discourage, the Chinese government to support their clean energy development. And this is why environmentalists hate the WTO.)

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