Treasury Department risks global currency war

Posted: May 24, 2005 12:00 AM

The Bush administration, without doubt, has put in place the best tax and economic policies since Ronald Reagan left office. When it comes to trade policy, however, the congressional pressures on the White House have had the unfortunate result of allowing political considerations to crowd out sound economic policy. And even more unfortunately, the pressure is coming from Republican members who should know better.

The administration is allowing itself to fall prey to the political temptation to placate the squeaky protectionist wheels on textile imports from China. What is doubly worrisome about this protectionist impulse, however, is that it has slipped the bounds of simply responding to political pressure by intense special interests for protection against international competition.

  True, the administration recently slapped import quotas on a wide range of Chinese textile imports, which, in themselves, are harmful. The case the Treasury Department is making for protectionist policies against China, however, is being based largely on more general principles seeking more far-reaching actions than simply hiking tariffs and instituting quotas.

Unfortunately, these principles are really an array of old economic fallacies regarding balance-of-trade flows, monetary policy and foreign exchange practices, which could do much more damage than simple quotas and tariffs. Basing protectionist policy on these principles could make it much more difficult for the administration to extricate itself and the country from the destructive policies it contemplates. The administration is applying relentless pressure on China to manipulate its currency, increase the value of the yuan relative to the dollar and, consequently, to slow economic growth and restrict its exports. If they succeed, it very well might encourage currency wars in the global economy.

I hope administration officials remember the wisdom of Reagan when it comes to htrade. He said, "I recognize ... the inescapable conclusion that all of history has taught: The freer the flow of world trade, the stronger the tides of human progress and peace among nations." As The Wall Street Journal pointed out, by fixing the value of the yuan at 8.28 to the dollar, the dollar-yuan exchange rate has been "an island of stability in this dynamic (economic) system, just as the euro serves that function for Europe." Given the extreme fragility of the Chinese banking system - the one vestige of communist cronyism and political manipulation untouched by capitalist reforms in China - forcing China to devalue its currency could set off a chain reaction of destructive economic events that would have ripple effects far beyond China's borders, not only economic but also political, as well.

On the home front, the U.S. Treasury Department's misleading rhetoric accusing China of "manipulating" its currency by maintaining its decade-long link to the dollar has only poured gasoline on the protectionist fires smoldering in textile regions of the country. One indication of how the strong administration rhetoric against Chinese monetary policy has fanned the protectionist flames in Congress is the proposed 27.5 percent protectionist tariff against all Chinese imports proposed by Sens. Charles Schumer, D-N.Y., Hillary Clinton, D-N.Y. and Lindsey Graham, R-S.C.

When the Senate recently refused to kill the Schumer tariff proposal, Graham is reported to have told a colleague, "I feel like the dog that caught the car." In other words, Graham recognizes how damaging such a tariff would be if actually imposed. However, he is under such intense political pressure from back home to stem the flow of cheap Chinese imports that over-the-top Treasury Department rhetoric about Chinese "currency manipulation" traps him into destructive symbolism, which could have disastrous effects if the symbolism became reality. Indeed, the administration itself may now be appreciating how Treasury's brinksmanship on the yuan may have cornered the White House into taking action it just as soon would avoid.

China has announced that it would take it upon itself to restrict its textile exports by placing a duty of 400 percent on some garment exports. It's clear China is attempting to head off a confrontation over de-linking the yuan from the dollar. Hopefully, this action will succeed in lowering the tension between the United States and China over the currency matter and give the Chinese time to begin strengthening their banking system.

Eventually, China will find it in its own self-interest to de-link its currency from the dollar, not to let float but rather to find another stable anchor for the yuan, such as gold or perhaps a currency board. Finding another stable currency anchor for the yuan not only would eliminate the U.S. government's ability to pressure China into a currency devaluation; it also would free China from importing cyclical waves of dollar deflation and inflation as U.S. monetary authorities continue to make monetary errors of their own by their persistent manipulation of interest rates to determine the value of the dollar.