Challenging China on trade

Twenty years ago, Americans were alarmed by reports of Japanese conglomerates buying major U.S. assets. Now we’re worried about China selling us too many cheap consumer products. The latter problem has a much more profound effect on the U.S. economy: The enormous trade imbalance with China — we buy far more of their goods than they buy of ours — has caused this country to lose millions of manufacturing jobs over the past decade.

The imbalance stems at least in part from China’s undervalued currency, which artificially lowers the cost of the goods it exports. Persistent criticism from U.S. officials has led China to let its currency (the renminbi, whose units are called yuan) grow in value relative to the dollar. But that growth has been too slow to make a significant dent in China’s trade surplus.

On Wednesday, a fed-up House of Representatives approved a bill (HR 2378)any country whose currency was deliberately undervalued by 5% or more. The measure poses risks for the U.S., not the least being the possibility of a trade war with China. But if threatening to enact it helps persuade China to let the yuan appreciate more rapidly, then the bill could achieve its goals without an economic shot being fired.

In theory, huge trade imbalances should be unsustainable. U.S. importers have to convert their dollars to yuan to buy Chinese goods, and with the trade imbalance, more dollars are being converted into yuan than yuan into dollars. The excess demand for yuan should drive up its value and make Chinese goods costlier for U.S. buyers.

But the Chinese government has counteracted that pressure by increasing the supply of yuan and snapping up dollars. By the end of June, it held more than $2.5 trillion in its foreign exchange reserves. By keeping the value of the yuan low relative to the dollar, it has helped Chinese manufacturers maintain their price advantage over U.S. companies. The policy also has hurt U.S. exports by reducing the buying power of the yuan, at least where foreign goods are concerned. In short, China’s efforts violate a fundamental principle of international trade law, which aims to stop governments from tipping the trading scales.

The House bill has some obvious shortcomings. Unilaterally imposing tariffs based on a novel theory that currency intervention can be an illegal trade subsidy may run afoul of the World Trade Organization, whose rules the U.S. has been pressing China to obey. The bill wouldn’t provide broad relief to manufacturers; instead, it would require them to bring complaints on a product-by-product basis, with each complaint taking more than a year to resolve. And it could set a precedent for other countries to impose tariffs on U.S. goods when the Federal Reserve drives down the value of the dollar by taking extraordinary steps to lower interest rates, as it has done during the current downturn.

A better alternative might be to levy a tax on dollar-to-yuan conversions for as long as the Chinese government intervenes in the value of its currency. In the meantime, though, the House bill sends an unmistakable signal to Beijing that U.S. lawmakers’ patience has run out. Hopefully the leverage the House is supplying will help the Obama administration persuade China to stop playing the currency game according to its own rules.