China: What Do We Want?

There is growing momentum to do something about the overvaluation of the dollar. This is a good thing. The overvaluation of the dollar has led to record trade deficits. While there is a well-funded industry devoted to whipping up hysteria around the budget deficit, the trade deficit actually poses a much more serious cause for concern.

The trade deficit, not the budget deficit, is the reason that other countries are acquiring large amounts of US debt. It really should make no difference to us whether foreigners own huge amounts of government debt or the debt is of private companies like General Electric or Microsoft. In either case, the foreign ownership of debt means an outflow of interest income from the United States to other countries.

And, if we are worried that evildoers will cause us great harm by dumping US government debt, as opposed to dumping dollar based assets more generally, then the potential evildoers can sell their GE bonds and Microsoft bonds any day of the week and buy government bonds. Then they could threaten to dump US government bonds. So, any serious concern about foreign ownership of the government debt should get us to focus on the trade deficit, not the government deficit.

There also is the key macroeconomic issue that a large trade deficit implies low national savings. If we have a large trade deficit then we must have either very low private savings or a large budget deficit, or some combination. That is not a pattern for healthy growth.

Of course, the reason that we have a trade deficit is that the dollar is overvalued. The point is really straightforward. We buy foreign made goods rather than domestically produced goods because the imports are cheaper. They are cheaper because an overvalued dollar makes them very cheap in dollar terms. Similarly, the overvalued dollar makes our exports more expensive in other countries.

Thankfully, the Obama administration and members of Congress are now starting to focus on the overvalued dollar. However, the debate is taking a somewhat perverse form as a beat-up on China crusade. This is not a very productive route.

The dollar is overvalued against many currencies, although the Chinese yuan is certainly the most important one, since China has the largest economy in the world after the United States. China fixes the value of its currency against the dollar at a price that is well below the market exchange rate. Any adjustment of currency values means that the dollar must fall against the yuan. It would likely also fall against many other currencies as well, since many countries effectively tie their own currency to the yuan.

This means that we should want the United States to negotiate with China to get a higher value of the yuan against the dollar. However, the effort to push the Obama administration toward this position has sometimes taken the form of an anti-China crusade. There have been a long list of complaints laid out against China, all of which are supposed to tie in with the effort to pressure China to raise the value of the dollar.

Some of these complaints are clearly legitimate. China is not a democracy; the government continues to practice censorship, and it does not respect labor rights. However, some other complaints are more questionable. For example there are complaints that it does not provide adequate protection for US intellectual property rights. Our financial industry has also complained that China’s market is not as open it should be to the likes of Goldman Sachs and Citigroup.

These issues are not about fundamental rights, but rather commercial dealings. Furthermore, the pursuit of these commercial interests is in direct opposition to the effort to raise the value of the yuan against the dollar to increase the competitiveness of US manufacturing.

The logic is straightforward. Any increase in the value of the yuan against the dollar will be achieved through negotiation. The US can take unilateral steps, but that is not likely at the moment. Since we are not in a position to impose everything we want on China – we have not defeated them in a war – the United States will not get everything on its shopping list in negotiations.

This means that insofar as we get concessions on paying Disney and Pfizer more for intellectual property or opening the door to Goldman Sachs, we will be getting less in the way of a higher valued yuan. In other words, if Disney and Goldman walk away happy; the rest of us should be unhappy with the deal.

The effort to raise the value of the yuan and improve the competitiveness of US manufacturing is not about getting a unified chorus of China-bashing. It’s about a negotiating process in which most people in the US and the world should hope that Disney and Goldman walk away as losers.