The collapse of world trade talks over the weekend has produced much hand-wringing in Bush administration. Yet it was the inevitable result of its own protectionist policies -- especially last year's budget-busting agriculture subsidy bill.
Since the whole point of the talks was supposed to be about reducing agriculture subsidies, raising such subsidies at the beginning of negotiations was a clear signal that the administration placed domestic politics above free trade.
Nevertheless, the collapse of trade talks is significant because protectionist pressure is rising. The only real hope of heading it off was the possibility of an international agreement that would force a reduction in tariffs, subsidies and other protectionist policies. Now that such an agreement is probably dead, the protectionists are strengthened.
China is the main target. Exhibit A is China's allegedly undervalued exchange rate. It is often said that the Chinese yuan would rise by 40 percent if allowed to float freely, rather than being pegged to the dollar. The effect is to make Chinese exports to the United States 40 percent cheaper in terms of dollars, and U.S. exports to China 40 percent more expensive in terms of yuan.
Before one can analyze this situation, it is important to understand that no one knows what the dollar-yuan exchange rate would be in the absence of pegging. Many currencies that float freely are often thought to be overvalued or undervalued for various reasons. So simply eliminating the peg does not guarantee that the yuan will rise. Indeed, some economists believe that the yuan might fall if China eliminated capital controls -- which it would have to do in order to have a free float -- and allowed its citizens to invest their savings outside the country.
Another thing to keep in mind is that it is just about impossible for a country to undervalue its currency against just one other currency. Currency traders would engage in arbitrage to take advantage of this anomaly to buy and sell other currencies so as to undermine the effort. In other words, the Chinese couldn't keep the yuan undervalued against the dollar without also keeping it undervalued vis-a-vis the yen, the euro and other currencies. So if the yuan is in fact undervalued against the dollar, then it is also undervalued against all other currencies.
But if the yuan is undervalued against all currencies, then it should be running a trade surplus with every country, not just the United States. In fact, China runs an overall trade deficit. Its surplus with us is more than offset by deficits with other countries.
Bruce Bartlett is a former senior fellow with the National Center for Policy Analysis of Dallas, Texas. Bartlett is a prolific author, having published over 900 articles in national publications, and prominent magazines and published four books, including Reaganomics: Supply-Side Economics in Action.
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