The Real Challenge From China: Its People, Not Its Currency

I love the idea of bipartisanship. Just the image of Democrats and Republicans coming together makes me smile. "Finally," I say to myself, "American government is working." But then I look at what they actually agree on, and I begin to pine for paralysis.

On Sept. 29, the House of Representatives passed a bill with overwhelming support from both Democrats and Republicans. It would punish China for keeping its currency undervalued by slapping tariffs on Chinese goods. Everyone seems to agree that it's about time. But it isn't. The bill is at best pointless posturing and at worst dangerous demagoguery. It won't solve the problem it seeks to fix. More worrying, it is part of growing anti-Chinese sentiment in the U.S. that misses the real challenge of China's next phase of development.
(Read "Geithner: We Need To Toughen Up With China.")

There's no doubt that China keeps the renminbi, its currency, undervalued so it can help its manufacturers sell their toys, sweaters and electronics cheaply in foreign markets, especially the U.S. and Europe. But this is only one of a series of factors that have made China the key manufacturing base of the world. (The others include low wages, superb infrastructure, hospitality to business, compliant unions and a hard-working labor force.) A simple appreciation of the renminbi will not magically change all this.
(See pictures of China's infrastructure boom.)

Chinese companies make many goods for less than 25% of what they would cost to manufacture in the U.S. Making those goods 20% more expensive (because it's reasonable to suppose that without government intervention, China's currency would increase in value against the dollar by about 20%) won't make American factories competitive. The most likely outcome is that it would help other low-wage economies like Vietnam, India and Bangladesh, which make many of the same goods as China. So Walmart would still stock goods at the lowest possible price, only more of them would come from Vietnam and Bangladesh. Moreover, these other countries, and many more in Asia, keep their currencies undervalued as well. As Helmut Reisen, head of research for the Development Center at the Organisation for Economic Co-operation and Development, wrote recently in an essay, "There are more than two currencies in the world."

We've seen this movie before. From July 2005 to July 2008, under pressure from the U.S. government, Beijing allowed its currency to rise against the dollar by 21%. Despite that hefty increase, China's exports to the U.S. continued to grow mightily. Of course, once the recession hit, China's exports slowed, but not as much as those of countries that had not let their currencies rise. So even with relatively pricier goods, China did better than other exporting nations.
(See pictures of the making of modern China.)

Look elsewhere in the past and you come to the same conclusion. In 1985 the U.S. browbeat Japan at the Plaza Accord meetings into letting the yen rise. But the subsequent 50% increase did little to make American goods more competitive. Yale University's Stephen Roach points out that since 2002, the U.S. dollar has fallen in value by 23% against all our trading partners, and yet American exports are not booming. The U.S. imports more than it exports from 90 countries around the world. Is this because of currency manipulation by those countries, or is it more likely a result of fundamental choices we have made as a country to favor consumption over investment and manufacturing?

Coming: The New China
The real challenge we face from China is not that it will keep flooding us with cheap goods. It's actually the opposite: China is moving up the value chain, and this could constitute the most significant new competition to the U.S. economy in the future.
(Read "Five Things the U.S. Can Learn from China.")

For much of the past three decades, China focused its efforts on building up its physical infrastructure. It didn't need to invest in its people; the country was aiming to produce mainly low-wage, low-margin goods. As long as its workers were cheap and worked hard, that was good enough. But the factories needed to be modern, the roads world-class, the ports vast and the airports efficient. All these were built with a speed and on a scale never before seen in human history.

Now China wants to get into higher-quality goods and services. That means the next phase of its economic development, clearly identified by government officials, requires it to invest in human capital with the same determination it used to build highways. Since 1998, Beijing has undertaken a massive expansion of education, nearly tripling the share of GDP devoted to it. In the decade since, the number of colleges in China has doubled and the number of students quintupled, going from 1 million in 1997 to 5.5 million in 2007. China has identified its nine top universities and singled them out as its version of the Ivy League. At a time when universities in Europe and state universities in the U.S. are crumbling from the impact of massive budget cuts, China is moving in exactly the opposite direction. In a speech earlier this year, Yale president Richard Levin pointed out, "This expansion in capacity is without precedent. China has built the largest higher-education sector in the world in merely a decade's time. In fact, the increase in China's postsecondary enrollment since the turn of the millennium exceeds the total postsecondary enrollment in the United States."

The Benefits of Brainpower
What does this unprecedented investment in education mean for China — and for the U.S.? Nobel Prize-winning economist Robert Fogel of the University of Chicago has estimated the economic impact of well-trained workers. In the U.S., a high school-educated worker is 1.8 times as productive, and a college graduate three times as productive, as someone with a ninth-grade education. China is massively expanding its supply of high school and college graduates. And though China is still lagging far behind India in the services sector, as its students learn better English and train in technology — both of which are happening — Chinese firms will enter this vast market as well. Fogel believes that the increase in high-skilled workers will substantially boost the country's annual growth rate for a generation, taking its GDP to an eye-popping $123 trillion by 2040. (Yes, by his estimates, in 2040 China would be the largest economy in the world by far.)
(See portraits of Chinese workers.)

Whether or not that unimaginable number is correct — and my guess is that Fogel is much too optimistic about China's growth — what is apparent is that China is beginning a move up the value chain into industries and jobs that were until recently considered the prerogative of the Western world. This is the real China challenge. It is not being produced by Beijing's currency manipulation or hidden subsidies but by strategic investment and hard work. The best and most effective response to it is not threats and tariffs but deep, structural reforms and major new investments to make the U.S. economy dynamic and its workers competitive. That's where we need bipartisan agreement. Someone? Anyone?

Read more: http://www.time.com/time/world/article/0,8599,2024090,00.html#ixzz11fjSYQ8j

Common Currency

Once again the U.S. and China find themselves in a spat over the Chinese currency, the yuan. Many politicians and economists in the U.S. believe that Beijing manipulates the yuan's value to keep it artificially cheap to give Chinese exports an unfair price advantage in international markets, thus holding back America's economic recovery. In a sign of growing frustration in Washington, a bill in the House of Representatives would direct the U.S. government to slap punitive duties on goods from countries that keep their currencies undervalued. The bill is clearly targeted at China. One of its authors, Congressman Tim Ryan, recently warned that the U.S. "cannot continue to look the other way as China's currency policies slowly but steadily smother what remains of our American manufacturing." An adviser to China's central bank shot back that Beijing "will not appreciate the yuan solely because of external pressure."

Beijing ended a two-year de facto peg between the yuan and the dollar in June. Since then, the yuan has appreciated less than 2% against the dollar, with much of that change suspiciously coming in the days surrounding congressional testimony by U.S. Treasury Secretary Timothy Geithner on China's yuan policy. Geithner said China intervenes in currency markets "on a very substantial scale to limit the upward pressure of market forces" on the yuan. How much the yuan is undervalued is a matter of speculation and debate. But clearly it is undervalued. We know this because it tends to get stronger when Beijing does allow its value to change.
(See pictures of China's infrastructure boom.)

Nevertheless, a stronger yuan is no cure-all for America's economic ills. Sure, if Beijing allowed the yuan to appreciate, China's giant trade surplus with the U.S. — the main target of Washington's ire — could shrink. Imports would become cheaper for Chinese consumers and companies, stimulating American exports to China and creating badly needed jobs in the U.S. But a stronger yuan would not automatically balance trade between the U.S. and China. Between 2005 and 2008, when the yuan appreciated about 21% against the dollar, America's trade deficit with China increased. China simply produces too many of the basic consumer goods Americans need to buy, from toys to PCs. That's why fixing the imbalances between the two countries will take much more than currency movements. It requires major structural reforms in both economies. Americans have to save more and spend less; Chinese have to spend more and save less.

A more expensive yuan can hurt Americans as well. It means heftier price tags on Chinese-made goods on Walmart shelves, taxing American consumers already stretched by unemployment and debt. Nor would a stronger yuan encourage factories and jobs to return to the U.S. from across the Pacific. Yes, yuan appreciation would make many export factories in China less competitive. But those factories would more likely relocate to the many other developing nations — India, Indonesia and so on — where costs are significantly lower than America's.
(See pictures of the making of modern China.)

Still, by strictly controlling the value of its currency, China's signal to the world is: We want to export to you for the good of our own recovery, not yours. That beggar-thy-neighbor agenda encourages others to pursue similar policies. On Sept. 15, Japan intervened in currency markets for the first time in six years to depress the value of a rising yen, hoping to help its exporters compete with those from China and elsewhere. That raises the specter of a round of competitive devaluations — just the kind of mercantilist nightmare that could derail the already shaky recovery from the Great Recession. By maintaining an undervalued yuan, moreover, Beijing is hurting poorer countries. The cheap yuan stunts their export sectors by keeping Chinese manufactured goods competitive vs. rival products from emerging economies with lower costs.

Most of all, China should reform its yuan policy for its own good. Policymakers fret that a sharp increase in the yuan's value would undercut the nation's export machine and cost valuable jobs. Yet China's past experience with yuan appreciation shows that its exporters can survive, and even thrive, not least because imported components and raw materials cost less. Beijing dreams of the yuan becoming a force in global trade and finance; that will never materialize unless the government loosens its grip. A stronger yuan would also pressure Chinese companies to become more efficient and high tech, which is a major goal of Beijing's. And it would help with the crucial transformation of China's invest-and-export growth engine to one based more on domestic consumption. That would make the economy less reliant on global demand, state spending and debt-driven investment.

A stronger yuan is good for just about everybody. Until Beijing awakes to that reality, China's controversial currency will remain a flash point in the country's relations with the rest of the world and an impediment to global economic progress.

Read more: http://www.time.com/time/magazine/article/0,9171,2020980,00.html#ixzz11fjrIxlf

Geithner: We Need To Toughen Up With China
Wednesday, Sep. 15, 2010



(WASHINGTON) — The Obama administration on Wednesday signaled a new get-tough approach with China, filing two trade cases against the country before the World Trade Organization and also complaining that Beijing is moving too slowly to reform its currency system.

Treasury Secretary Timothy Geithner, in prepared testimony, said the administration is considering what tools it might use to push China to move more quickly to allow its currency to appreciate in value against the dollar.
(See pictures of China's infrastructure boom.)

Separately, U.S. Trade Representative Ron Kirk announced that the administration was filing two new trade cases against China before the Geneva-based WTO, which oversees the rules of global trade.

"We are concerned that China is breaking its trade commitments to the United States and other WTO partners," Kirk said in a statement.

In one of the WTO cases, the administration said China is discriminating against U.S. credit and debt card companies in favor of a state-owned financial services firm. The other case contended that China has improperly imposed trade sanctions on a type of U.S.-made flat-rolled steel used in electric transformers, reactors and other types of power-generating equipment.
(See pictures of the making of modern China.)

The two trade cases filed by Kirk's office could lead to retaliatory U.S. sanctions against Chinese products if the WTO rules in favor of the U.S. complaints. The two countries will have 60 days of consultations to try to resolve the disputes before the WTO sets up hearing panels.

Geithner's comments on China's currency practices were the toughest he has made. Both the WTO cases and Geithner's remarks underscore the frustration the administration feels about a sensitive trade issue less than two months before congressional elections.

"We are concerned, as are many of China's trading partners, that the pace of appreciation has been too slow and the extent of appreciation too limited," Geithner said in testimony he was to deliver before the Senate Banking Committee and the House Ways and Means Committee on Thursday.

In Beijing, Chinese government officials said there would be no immediate reaction to the new trade cases or to Geithner's comments. Earlier Wednesday, Yao Jian, a spokesman for China's commerce ministry said that any effort to use China's trade surplus with the United States to bring pressure over Beijing's currency system would be unreasonable.

American manufacturers contend that China's currency is undervalued by as much as 40 percent, making Chinese goods cheaper in the U.S. market and American products more expensive in China.

U.S. manufacturers contend that by manipulating its currency, Beijing is giving its companies a significant trade advantage that has led to a soaring U.S. trade deficit with China and the loss of millions of U.S. manufacturing jobs.

The Obama administration, like the previous Bush administration, has preferred to pursue a course of quiet diplomacy with China, believing that would produce greater results that direct confrontation with the Chinese on the currency issue.

However, Geithner's remarks indicate that policy may be changing.

Geithner said that the administration would take China's action into account when it releases its next report on the Chinese currency, which is due on Oct. 15.

Up until now, the administration has declined to label China a currency manipulator, a designation that would trigger talks between the two nations and could lead to trade sanctions if the United States won a case against China's currency policies before the World Trade Organization.

"We will take China's actions into account as we prepare the next Foreign Exchange Report and we are examining the important questions of what mix of tools ... might help the Chinese authorities to move more quickly," Geithner said.

Starting late last week, China's central bank has allowed the currency, the yuan, to rise more in value against the dollar. The yuan's trading range is controlled by the Chinese government.

Even with the gains in recent days, the yuan has strengthened by only a little more than 1 percent against the dollar since June 19. It was on that date that the central bank said it would drop a tight peg it had maintained between the yuan and the dollar for the past 23 months.

The June announcement came right before China was to attend a summit of the Group of 20 major industrial and developing countries in Toronto. The United States had indicated it would make China's currency system a key topic at that meeting unless the Chinese showed greater flexibility.

AP reporter Cara Anna in Beijing contributed to this report."

Read more: http://www.time.com/time/nation/article/0,8599,2019508,00.html#ixzz11g7GBL3d