by Ian Fletcher
THERE IS NO FREE MARKET IN CURRENCIES
There is an even more fundamental problem with just waiting for the free market to fix currency values: in reality, there is no free market in currencies. The advantages to be gained by manipulating a nation’s currency are simply too large for governments to resist the temptation. For example, according to the Automotive Trade Policy Council, Japan’s currency manipulation gives its exporters a per-car advantage averaging $4,000 and reaching up to $10,000 on high-end vehicles like the Infiniti.281
China, currently the most notorious offender, manipulates the exchange rate between its yuan and the dollar mainly by preventing its exporters from using the dollars they earn as they wish.282 Instead, they are required to swap them for domestic currency at China’s central bank, which then “sterilizes” them by spending them on U.S. Treasury securities (and increasingly other, higher-yielding, investments) rather than U.S. goods. As a result, the price of dollars is propped up by a demand for dollars which does not involve buying any actual American exports. The amounts involved are astronomical: as of 2008, China’s accumulated dollar-denominated holdings amounted to $1.7 trillion, an astonishing 40 percent of China’s GDP.283 The China Currency Coalition, a Washington lobby group, estimated in 2005 that the yuan was undervalued by 40 percent;284 past scholarly estimates have ranged from 10 to 75 percent.285
Forcing China to stop manipulating its currency is sometimes suggested as a solution.286 The most recent effort in this direction is the Currency Reform for Fair Trade Act of 2009.287 This bill would make it official American policy to deem China’s currency manipulation an illegal subsidy under WTO rules, thereby claiming the right to apply countervailing duties if China does not stop.
But this effort, though well-intentioned, is misguided. Above all, China’s currency is manipulated relative to our own only because we permit it, as there is no law requiring us to sell China our bonds and other assets. We can, in fact, end this manipulation at will. All we would need to do is bar China’s purchases or tax them to death. This is roughly what the Swiss did in 1972, when economic troubles elsewhere in the world generated an excessive flow of money seeking refuge in Swiss franc-denominated assets. This drove up the value of the franc and threatened to make Swiss manufacturing internationally uncompetitive. To prevent this, the Swiss government imposed a number of measures to dampen foreign investment demand for francs, including a ban on the sale of franc-denominated bonds, securities, and real estate to foreigners.288 Problem solved.
If China’s currency manipulation is so harmful and easy to stop, why haven’t we done something about it long ago? Mainly because if China ever did stop bingeing on American debt and assets, this would entail it ceasing to ship hundreds of billions of dollars per year of (quite cheap, as it mostly gets the low interest rate paid on government bonds) capital to the U.S. If we didn’t then raise our abysmal savings rate to take up the slack, this would sharply raise our interest rates, simply by the operation of supply and demand for capital. So it is our own inability to raise our savings rate that is the binding constraint here, not anything China does or does not do. We should indeed end China’s currency manipulation, but this is something we must do for ourselves, not twist China’s arm to do. Ironically, China is probably doing us a favor by not giving in to our pressure until we are ready to handle the consequences.
There is an even more fundamental question here. Why treat floating exchange rates as an ideal in the first place? The tacit presumption is built into the debate over exchange-rate manipulation that the alternative is floating rates. (The idea that the underlying problem is interference with the free market appeals mightily to people ideologically committed to free markets.) But, to be quite honest, what we really want isn’t floating rates at all: it’s just manipulated rates more advantageous to the U.S. There’s nothing wrong with this—we have as much right to play the international economic game for our own benefit as any other nation—but we shouldn’t delude ourselves into thinking it’s a free-market solution.
The reality? Our choice isn’t fixed vs. floating rates, it’s fixed vs. manipulated. And if exchange rates are destined to be manipulated no matter what, then going back to an explicit fixed-rate system, like the Bretton Woods agreement discussed in the previous chapter, might well be the best solution. Fixed exchange rates are, in fact, precisely the outcome when everybody manipulates their exchange rate, reaches a stand-off, and codifies the result.
China must eventually stop manipulating its currency at some point because the further the manipulated rate departs from the rate that would otherwise prevail, the more expensive this gets. The longer China keeps at it, the greater China’s future loss because the size of China’s dollar-denominated holdings, and their likely future drop in value, both grow. Pegging the yuan to a declining dollar also raises inflation in China by raising the price of imports, especially oil, and encourages financial speculation.289
Yuan-dollar unpegging is already happening, albeit in very small steps. China first started diversifying its reserve holdings away from the dollar (which has this effect) in July 2005, and from then until July 2008 allowed the yuan to rise from 8.28 to the dollar to 6.83, where it has since been held nearly steady. Does this mean the problem will solve itself automatically? No. For a start, the aforementioned appreciation, while showcased by Beijing, is nominal appreciation; after adjusting for inflation, the change was far smaller: about two percent.290 In any case, as Bush Treasury Under Secretary for International Affairs David McCormick put it in 2007, a more expensive yuan:
Will not provide a magic bullet for solving the problems of American industries facing overseas competition...We have already seen the resilience of China's exporters to currency appreciation.291
This is so because Chinese currency manipulation is, of course, only one facet of China’s low-cost strategy. The China Price Project at the University of California at Irvine has estimated its various components thus:292
Chinese Cost Advantages
Wages
39.4%
Subsidies
16.7%
Network Clustering293
16.0%
Undervalued Currency
11.4%
Counterfeiting & Piracy
8.6%
Foreign Direct Investment
3.1%
Health & Safety Neglect
2.4%
Environmental Neglect
2.3%
Even if China did revalue its currency, it has enough other tricks up its sleeve, in the form of non-tariff barriers, that it could go on its merry way and still leave America with trade almost as unbalanced as before. Protectionism doesn’t only mean obvious policies like tariffs and quotas; it also includes local content laws, import licensing requirements, and subtler measures (some of them covert, hard to detect, or infinitely disputable) such as deliberately quirky national technical standards and discriminatory tax practices. And it includes outright skullduggery such as deliberate port delays, inflated customs valuations, selective enforcement of safety standards, and systematic demands for bribes.294 One study by the Congressional Research Service identified 751 different types of barriers to American exports worldwide.295
Critics who go the next logical step and demand that China eliminate these covert trade barriers are unrealistic. Getting foreign nations to change domestic policies for the benefit of foreigners is a tricky matter even with polite liberal democracies such as Canada. Expecting this to happen with the authoritarian nationalists of Beijing is laughable. Even if China’s protectionist policies actually hurt it—a repeated claim of free traders—China’s government obviously doesn’t think so, as it chooses to define its own national interest. And China is a grandmaster of evading foreign economic pressure. It has thwarted, for example, the market opening agreements it made upon joining the World Trade Organization in 2001, often honoring their letter while evading their spirit.296
The ongoing decline of the dollar, c
ombined with recession, has already produced a dip in our trade deficit in 2009, so we may be fooled into thinking the problem is correcting itself. But our trade balance also temporarily improved due to recession in 1970, 1973, 1981, and 1991.297 So we may yet again decide to let our underlying problems continue to fester. This is a false salvation to watch out for very carefully.
Chapter 4
Critiques of Free Trade to Avoid
Because free trade has so many flaws and causes so many problems, it is tempting to throw at it every criticism we can think of. After all, if it is wrong, why not? But this would be a mistake. It would lead down time-wasting blind alleys, undermine attempts to ignite fruitful debate on the issue, hand free traders spurious arguments they can win, and ultimately mislead the public about the right alternatives. Because, like it or not, some of the most popular critiques of free trade in circulation are mistaken.
Some such criticism has alienated itself from the political mainstream that runs America by its openly anticapitalist, socialist, or even anarchist character. This invites automatic rejection by anyone who does not share its radical premises, as few voters or people in power do. Such criticism can even be counterproductive when it gives the public the impression that only its premises constitute good grounds to reject free trade, implying that anyone who does not share them should accept it. That is when the sheer antics of radical critics don’t give opposition to free trade a freakish image that forecloses discussion with a snigger and a video clip of some teenager with green hair smashing a Starbucks window. That kind of radicalism certainly has its place in America (Boston Tea Party, anyone?) but street theatre is only effective as part of an overall strategy. The battle over free trade will be won or lost in Middle America, not Greenwich Village.
Only an appeal to the self-interest of the average American voter will shift policy. So it is best to avoid mushy complaints like the idea that free trade is bad because it endorses a materialistic way of life or an obsession with economic efficiency. To some extent, of course, it may, and this is easy to bundle into a feel-good package that connects to a lot of other important issues.298 But this is really a critique of consumer society as a whole, which is not something Congress can legislate out of existence. Free trade is.
Another idea to avoid is that imports as such are bad—an easy attitude to slip into tacitly even if one does not literally believe this. Imports constitute consumption, which we must define as good if we embrace broadly shared prosperity and thus a consumer society. We must, in fact, assume imports are good to enable some of the most potent arguments against free trade. For example, free trade can cause trade deficits, run down a nation’s currency, make imports more expensive, and thus reduce living standards. So the anti-free trade position can actually be the pro-imports position in the long run! (This especially should be pointed out when free traders act as if they were defending the very concept of trade, as they often do.) Nobody serious wants to turn the United States into North Korea, which seals itself off from imports entirely.299
GO FOR THE JUGULAR: THE HARD ECONOMICS
Only destroying the credibility of the actual hard economics of free trade will destroy the power of free traders, by destroying their reputation for technocratic competence and the moral high ground that flows from this in a technocratic society. Therefore criticism of free trade must focus on the jugular vein of its economics, not side issues like culture. These issues are profoundly important in their own right, and naturally emotionally vivid, but this doesn’t make them effective tools for ending free trade. In public debate, what people tend to take away from side-issue critiques is that if criticism of free trade is about side issues, then the economics itself must make sense. This is fatal, as most people naturally assume that the economics of free trade should determine whether we continue it. Side-issue critiques are also too easy for free traders to respond to by offering non-trade-related interventions to fix any given problem, combined with continued free trade (which has been elevated to a formal ideal by economists like arch-free trader Jagdish Bhagwati of Columbia University).300
For example, protection of movies and magazines is a legitimate issue, but it is a cultural question that cannot be settled on economic grounds either way. It is, however, certainly illogical to demand that the world accept cultural homogenization because the protection of local cultures against Disneyfication interferes with free trade. Indeed it does, but we don’t export weapons to our military enemies (even when this might be profitable) because we recognize that arms are not essentially economic in nature and therefore ought not be governed by economic logic.301 No economic calculation can determine, for example, whether protecting a separate Canadian film industry is a boon to Canadian culture or just a subsidy for mediocre movies. That question, which is a live issue under NAFTA, can only be settled by film critics and audiences.
NO NEED FOR VILLAINS
If free trade is wrong, then it is coldly, factually wrong on its merits, and turning it into a drama of innocents and villains is unnecessary.
Sometimes the Third World is presented as an innocent victim of a First World trying to use free trade to keep it down. This view was expressed by the former Prime Minister of Malaysia, the bigoted but not unintelligent Mahathir bin Mohamad, thus:
Japan was developing at a time when the Western countries did not believe that Eastern countries could actually catch up with the West, so Japan was allowed. And then, of course, later on, when Japan appeared to be doing too well all the time, the yen was revalued upwards in order to make Japan less competitive. You can see that these are deliberate attempts to slow down the growth in Japan... and after that, of course, Southeast Asian countries, even Malaysia, began to develop fast, and there seemed to be a fear that Eastern countries might actually pose a threat to Western domination, and so something had to be done to stop them.302
Mahathir basically accuses the developed world of seeking to lock in its present industrial advantage, leaving the rest of the world supplying it raw materials and low-value industrial scraps. Third World nations often (understandably) perceive this as a rerun of colonialism.
But it is implausible that the First World is doing this. For a start, if it has the control over the world economy Mahathir imagines, then it should have succeeded by now. Yet Third World giants like China and India surge ahead. It is also unlikely that the First World corporations which actually conduct international trade serve the interests of the nations in which they are headquartered, as opposed to their own profits. Economic, political, and technological power are just too widely distributed in the world today for the literal fulfillment of Mahathir’s scenario, even if anyone seriously wanted it (which is doubtful).
Sometimes the Third World is cast as the villain. But whatever harm Third World nations like China have done to America through trade, most has been due to our own foolishness in embracing free trade. The protectionist America of 1925 would have been barely scratched. Only a limited amount consists of things, such as industrial espionage and brand piracy, which really are inexcusable outright theft. (These are a genuine problem: two-thirds of the American computer software used in China is stolen, according to one estimate,303 and copyright theft there is estimated to cost the U.S. $2.6 billion a year.)304
Another villain theory is that big corporations are evil—an accusation heard at both extremes of the political spectrum, though the Right tends to use words like “treasonous.” But corporations don’t behave as they do because they are evil (or disloyal). They behave as they do because the rules they operate under make certain behavior profitable. If free trade is legal, we should not get morally indignant when corporations fire their high-cost American workforces and move production overseas. We should change the rules that allow this.305 Competitive pressures force even corporations that would rather not act this way—they certainly exist—to go along.
FAIR TRADE IS NOT ENOUGH
The idea of fair trade is very appealing. Unfortunately,
it will be only a small part of any trade solution. Fair trade in goods like coffee is a fine thing because there exists a clear idea of unfair practices in how coffee importers treat coffee farmers and how to avoid them. That sort of fair trade basically consists in First World consumers voluntarily not using the full strength of their bargaining position with Third World producers. This is admirable. But fair trade embraces less than one percent of trade in cocoa, tea and coffee, so it will have a small impact for the foreseeable future.306
Can the idea scale? Perhaps. But there is currently a huge sandbag blocking it from further acceptance: mainstream economics holds that it is largely futile or counterproductive. For example, it holds that the price supports implied by fair trade encourage overproduction and drive down the price for other growers. So this economics must carefully be picked apart, using its own conceptual vocabulary, before fair trade can even get a decent hearing outside those already committed to it.
The more important meaning of fair trade concerns issues like what is the fair share for U.S. firms in the Chinese airliner market? Because the greater share of America’s trade problems concerns products like airliners, not coffee. These high-tech, high-value products are decisive for U.S. trade performance and will be the main objects of any future American industrial policy. These products are what American jobs will depend on.