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China holds a huge dollar balance arising out of its robust export machinery to the US, writes M R Venkatesh.
In a tight race both know that they need a big bad ugly villain. Remember without a villain a story is only half told. It is much better if the villain is bigger, alien and is perceived to do something sinister. Without bashing one, how do you expect a candidate to emerge as a hero?
Given this paradigm, for both US presidential candidates, China fits the bill perfectly. No wonder according to press reports China figured 21 times - yes 21 times - in the second debate between Obama and Romney. Both the candidates believe, China robs Americans of their jobs. Crucially, they want us to believe that China is responsible for the mess in US.
Obama argued "If you're a small business or a mom-and-pop business or a big business starting up here, you've got to pay even the reduced rate that Governor Romney is talking about. And it's estimated that that will create 800,000 new jobs. The problem is - they'll be in China, or India, or Germany." [That he named India, albeit negatively, was sufficient to keep most of us happy!]
But the most crucial one was by Romney who said "China has been a currency manipulator for years and years and years. And the president has a regular opportunity to label them as a currency manipulator, but refuses to do so. On Day One, I will label China a currency manipulator." The crucial question is - Will he? Can he?
At the core of the issue is the allegation that China has pegged its currency far too below its "actual" value which in turn facilitates Chinese exports to US, thereby causing loss of jobs in US.
More importantly, hardliners in US further accuse that substantial portion of Chinese build up of its 3 plus trillion dollar forex reserves is on account of gargantuan export surplus to US.
Look from a different perspective: China holds a huge dollar balance arising out of its robust export machinery to the US. That has security and strategic implications. Should the Americans get too tough on the Chinese on any matters; the later can bring the dollar value crashing.
An elaborate exercise in Semantics
Naturally all this has Americans perturbed. When troubled, like all democracies, Americans go to the drawing board, constitute committees, consult experts and draw the (right?) conclusions.
It is in this connection that the US Federal Government has constituted a "US-China Security Review Commission" to "monitor, investigate, and report to Congress on the national security implications of the bilateral trade and economic relationship between US and China."
This annual report provides important pieces of information about China and how the US views developments in China. Almost a decade ago in 2003, the US exports to China was valued at $28 billion while the imports from China accounted for $152 billion. Significantly, exports to US constituted 35 per cent of total Chinese exports at that time.
Even then the alarm bells had rung. A trade deficit of $124 billion was unacceptable to the Americans in 2003. The villain of the piece? The Chinese currency - Yuan.
The 2004 Report had pointed out "Economic fundamentals suggest that the Chinese Yuan is undervalued, with a growing consensus of economists estimating the level of undervaluation to be anywhere from fifteen to forty per cent."
It further adds "A key factor contributing to the US deficit with China is the undervaluation of the Chinese Yuan against the US dollar. This gives Chinese manufacturers a competitive advantage over US manufacturers."
"China's policy of keeping the RMB undervalued..." Now if you thought that this is from the 2004 Report, you are wrong. This is from the 2011 Report!
Put pithily, for over a decade Americans have barked but not bitten. Currently, the US trade deficit with China is in excess of $275 billion and Chinese exports to US accounts for more than fifty per cent of its total exports.
As the old arguments are recycled, the 2011 Report seeks to pontificate China of how an undervalued Yuan is in effect harmful to the Chinese economy. Well, that is akin to a rape victim worrying about the long arm of law catching up on her aggressor.
In an election year bravado and hyperbole are to be expected. While the exact number of U.S. jobs lost to China trade is hotly disputed economist C Fred Bergsten has estimated 600,000 jobs on the low end.
On the high end, a Briefing Paper prepared by the Economic Policy Institute states "Between 2001 and 2010, the trade deficit with China eliminated or displaced 2.8 million jobs, 1.9 million (69.2 per cent) of which were in manufacturing.
And the root cause of all this mess? You guessed it right either way it it is the undervalued Chinese Yuan!
Based in such "Reports" and "Studies," both Houses in the US Congress passed the "Currency Reform for Fair Trade Act" recently, getting bi-partisan support from both Democrats and Republicans.
Despite all these intellectual and legislative support, Obama administration has not acted yet. Why? Or is he is unwilling to act? Or is he unable to act. Let us explore further.
Can Romney Act?
On his part Obama acted tough on China by slapping duties on low-priced Chinese-made tyres imported into US, which according to him saved in excess of 1,000 jobs.
Economists at the Peterson Institute for International Economics in Washington have calculated that some thousand-odd jobs might have been saved, but that the cost amounted to $1.1 billion in higher prices to American consumers or $900,000 per job. Surely, a countervailing duty is self-defeating idea in the American context!
Given this paradigm, most tyre consumers are not going to view Obama favourably when to go the polling booth. That explains why, unlike Romney, Obama is not taking aggressive position on China.
That is not all. If the debilitating impact of an undervalued Yuan is a subject of intense debate in US, economists are equally split as to the extent of undervaluation.
Calculations carried out in May 2012 by the Peterson Institute, a Washington based think-tank, shows the Yuan to be undervalued by 7.5 per cent against the dollar, far below the last year's estimate of a 28 per cent. This is much lower than the popularly perceived fifty per cent.
Recently the IMF has recently reclassified the Yuan to "moderately undervalued" from "substantially undervalued."
It is no co-incidence that that the US views on Yuan about valuation has undergone some tectonic shifts. The 2011 Report, as pointed out earlier, on the US-China Security review Commission laments about the undervaluation of the Yuan, the fact remains that the Americans seemed to be too concerned about its consequential impact, especially on inflation in China!
Similarly, Romney does not seem to realise that it is no longer China exports cheap poor quality goods - rather it exports high quality and sophisticated goods. It is the world's largest manufacturer and exporter. Any action against China is no longer going to be easy. Period.
In short, should Romney act, hold the Chinese responsible for manipulating their currency on "day one" as he promised, and levy countervailing duties on Chinese imports, it is quite possible that he could just be having very little headroom as explained above.
And should he do so, he could well risk raising prices of antagonising American consumers who are well and truly used to "low" cost Chinese goods.
More importantly any such act by Romney, more so if it were unilateral, has the calculated effect of dynamiting the WTO architecture, ushering in trade and currency wars. All these are sufficient deterrents for Romney to act tough. But that does not preclude him from issuing threats.
What is forgotten in the melee is that in the interregnum the Chinese have allowed their currency to appreciate (albeit at a glacial pace), allowed outbound investments and stabilised inflation through a series of monetary policy interventions.
All this has the calculated effect of preventing a rapid rise in foreign exchange reserves while evened out exchange rates at current levels.
Remember, in the run up to the elections in 2008 Obama issued a similar threat to protect the certain US businesses from an undervalued Yuan. After winning the election, his administration spent roughly four months investigating whether China was artificially suppressing its currency. The conclusion? China was not manipulating its currency.
It is quite possible that Romney will declare China to be a currency manipulator on "day one." But he would go no further. He would simply shy away from doing any further after declaring China to be a currency manipulator. That would suit everyone - possibly including the Chinese.
At least on China, I am sure, Romney is not serious.
Photograph: Brian Snyder/Reuters
The author is a Chennai-based Chartered Accountant. Comments can be made at mrv@mrv.net.in