China, the dollar, and trade

In an article in the New York Times Greg Mankiw says It's No Time for Protectionism. And he is right.

Mankiw writes

Just before his confirmation as Treasury secretary, Timothy F. Geithner turned up the heat on the Chinese regarding the dollar-yuan exchange rate. President Obama, he said, “believes that China is manipulating its currency. Countries like China cannot continue to get a free pass for undermining fair-trade principles.”

Like many economists, I cringe whenever I hear the term “fair trade.” It is not that I am against fairness — who is? — but the word “fair” is so amorphous in this context as to defy definition. Most often, the slogan “fair trade” is little more than a rallying cry for protectionism.

On the question of China manipulating its currency Mankiw asks

But timing aside, is Mr. Geithner right about the currency question? Are Americans hurt by China’s exchange-rate policy?

And the answer is, of course, yes and no. Mankiw writes

Critics of China say it is keeping the yuan undervalued to gain an advantage in the international marketplace. A cheaper yuan makes Chinese goods less expensive in the United States and American goods more expensive in China. As a result, American producers find it harder to compete with Chinese imports in the United States and to sell their own exports in China.

There is, however, another side to the story. The loss to American producers comes with a gain to the many millions of American consumers who prefer to pay less for the goods they buy.

So, some exporters and import substitution industries will face hard times, but consumers face cheaper prices. Mankiw continues

Mr. Geithner and other China critics might also want to ponder how the Chinese keep the yuan undervalued. The essence of the policy is supplying yuan and demanding dollars on foreign-exchange markets. The dollars that China accumulates in these transactions are then invested in United States Treasury securities.

So when the Treasury secretary complains about the undervalued yuan, his message to the Chinese boils down to this: Stop lending us money.

Not surprisingly, after Mr. Geithner made his remarks about the Chinese currency, the prices of Treasuries fell and yields rose. If China took him seriously, long-term interest rates would rise even more. As the United States embarks on a path of unusually large budget deficits, the nation’s chief financial officer should pause and think carefully before turning up the heat on one of its biggest creditors.

Also it is not clear why the US is rising this issue now. In the overall scheme of things it isn't that important right now. Mankiw quotes Olivier Blanchard, the chief economist of the International Monetary Fund, as saying

“It is probably not the right time to focus on the Chinese exchange rate, given that it is not a central element of the world crisis. There are many other things we should be thinking about.”

And Blanchard has a point. But directing the world's attention to the China currency issue amid a worldwide recession and growing fears of depression is unfortunately more than just a distraction. As Mankiw says "It is downright counterproductive". He adds

Senators Charles E. Schumer, Democrat of New York, and Lindsey Graham, Republican of South Carolina, have long proposed dealing with the yuan undervaluation by imposing tariffs on Chinese imports. The Treasury secretary’s comments risk stoking those protectionist embers.

Indeed, protectionist influences seem to be finding their way into the stimulus bill winding its way through Congress. The bill passed by the House included a provision banning the use of foreign iron and steel in infrastructure projects. The Senate has adopted a somewhat more flexible restriction (after voting down an amendment by John McCain to strip the “Buy American” provision from the bill).

But perhaps the worst thing is that as Maniw notes the president isn't taking a strong stand against protectionism.

Despite having hired many first-rate economists with impeccable free-trade credentials, the president has been only tepid in his public opposition to this creeping protectionism.

This really is one issue at one time where the worlds needs strong leadership from the US. President Obama has to kill these protectionist moves within the US stone dead. The world will not thank him for beginning a new round of trade wars.