A Tangled Web

Asia Times has a very interesting story discussing the Bush administration's moves attempting to get China to revalue the yuan. They are critical of this policy for number of reasons. (FYI, it looks like China is rejecting this pressure in any case...)

First is that we have been running a huge trade deficit with China for some time (which is, of course, the administration's reasoning for this move). During this time China has been piling up US currency, but they have little motivation to buy anything from the US (or anyone else) with it. What can they get from the US that they can't produce cheaper themselves? So in an effort to do something productive with this money they've mostly been buying US government securities (ie financing the US federal budget deficit). If the US reduces this trade deficit at the same time that our budget deficit soars to record levels it will become difficult to find takers for securities to finance our debt. This will result in the US raising interest rates in order to make the securities more attractive, countering Alan Greenspan's intensive efforts to stimulate the US economy with low interest.

They also mention that a majority of the products imported from China are actually produced by American companies (something highlighted in the Oxfam report as well). To some extent this makes the trade deficit illusory (or at least makes it appear much worse than it is). Forcing these companies out of China will make their products more expensive and less attractive on the world market and could end up hurting American business.

Additionally it will have the effect of making products more expensive to Americans (whether the products continue to come from China, or are manufactured elsewhere, including the US), stifling US consumer spending or driving up consumer debt, which is already at dangerous levels.

Finally, the article does not discuss this, but I wonder how much of that manufacturing would return to the US even if China becomes less attractive? Wouldn't Indonesia, the Philippines, and India still be more attractive places to move these manufacturing centers to? I think there would have to be a more intensive effort to devalue the dollar to actually bring manufacturing back home. There is also a CSM article today discussing this general topic.

In all it becomes a very difficult situation to project. However, one thing is clear in all this: our massive budget deficit and national debt clearly constrain our ability to control our own economy with regards to international trade. These are penalties beyond simply mortgaging our future prosperity and indebting future generations. The debt locks our monetary and fiscal policies together, forcing us to make a choice between them. We can keep interest rates low to try and spark growth, but it means maintaining a strong dollar which hurts trade. Or we can devalue the dollar to reduce our trade deficit, but it will cost us higher interest rates to finance our debt. We can't have both.