Last week’s US legislation to place high tariffs on China’s imports could lead to an all out US-Sino trade war – and that could have devastating consequences for both, and for the global economy, says Simon Wilson.
What’s happened?
Last week the US House of Representatives fired a decisive warning shot at China. It passed legislation that would allow America to slap huge tariffs on imports from countries that artificially hold down their currencies to seek a competitive advantage.
Many economists and governments blame China for refusing to let the renminbi trade at its true value (thus boosting exports and helping create a whopping trade surplus). It is also accused of subsidising exporters with ultra-low interest rates. The IMF now warns that the world may be heading for an all-out currency war.
How has China responded?
According to foreign ministry spokesman Jiang Yu, any protectionist moves by America would spark a trade war that would be against “the interests of both peoples and people around the world”. But many in the US believe a trade war is already being fought unilaterally by China while America dithers.
Last week, Brazil’s finance minister warned that other countries are being sucked into a dangerous international currency fight due to a series of undeclared, beggar-thy-neighbour competitive devaluations. He was talking not only about China, but also about the US policy of de facto devaluation via ultra-loose monetary policy. He vowed to take action to protect Brazil’s currency from appreciating too far – for example, by raising taxes on capital inflows.
Who else is worried?
Japan recently intervened in the currency markets for the first time in six years, accusing China of driving the yen to a 15-year high, in part by buying Japanese debt. Other nations that have recently intervened to stop their currencies rising too far include Korea, Thailand, and Colombia. In Europe, where exports are helping sagging economies, there are concerns about the euro’s sharp rise in recent months.
France’s President Sarkozy, who starts his turn as head of the G20 next month, said last weekend that he would be pushing for a new system to co-ordinate global currencies. This week the Institute of International Finance, which represents more than 420 of the world’s leading banks and finance houses, called for a new currency pact to help rebalance the global economy. Some commentators have even called for a back-to-the-future reversion to a currency system based on the gold standard.
Is China the main culprit?
Not according to Morgan Stanley’s ex-chief economist, Stephen Roach. He reckons America would be wrong to blame China for the stagnating US economy and sees the drift towards a trade war as potentially disastrous.
In an interview this week with the US business newspaper Barron’s, Roach points out that the US ran trade deficits with 90 countries last year. Although China’s was the largest, the other 89 together accounted for more of the total.
So America has “a multilateral trade balance – not a bilateral problem with China. And the reason is we don’t save. Our overall savings rate as a nation last year was negative, at minus 2.3% of national income. That’s the lowest for a leading country in the modern history of the world.”
So sanctions could backfire?
Trade sanctions against China could be pointless – target China and the US consumer will be hit even harder by the higher-cost producers that would replace it. Worse, sanctions risk triggering a global plunge into protectionism that would backfire on America when the Chinese retaliate.
China is America’s third-largest export market: it could easily make a tit-for-tat response. If things get really nasty, China could simply stop buying US government debt. The result? US interest rates soar, the dollar’s position is threatened, and America is tipped back into recession.
Is China’s influence really that strong?
Some economists agree that China’s manipulation of its currency is protectionism by any other name, and deserves to be punished. For example, Capital Economics’ Roger Bootle recently argued in The Daily Telegraph that China is all but forcing America into launching a trade war.
Yet it has much to lose – as a major surplus country – from a wider breakdown in free trade. In such a scenario, the US would gain jobs as China lost them, with potentially dire consequences for China’s political stability.
Beijing might then try to boost domestic demand by letting the renminbi rise. But it might choose to slap tariffs on US and other imports, resulting in a 1930s-style descent into global protectionism in which everyone loses. The stakes for the global economy could hardly be much higher.
Will America back down?
While some influential economists, such as Stephen Roach, urge caution – the US should let China continue its long-game strategy of maintaining stability and revaluing the renminbi gradually – there are other, equally high-profile, economists who think the time has come to call China’s bluff.
Last week in The New York Times Paul Krugman reasserted his argument that US policy-makers have become infuriatingly passive in the face of de facto Chinese protectionism. He believes there are worse fates than a trade war, such as mass unemployment and chronic lack of growth.
Similarly, in The Washington Post, Robert Samuelson – normally a staunch defender of free-trade orthodoxy – argued that the risk of a trade war has become one that is now well worth taking.