China Reacts to Geithner Testimony

When I posted about Treasury Secretary nominee Tim Geithner’s testimony during a confirmation hearing the other day, I failed to point out the real significance of his agreeing with the committee that China is manipulating its currency.  This is a clear signal that the Obama administration plans to officially label China a “currency manipulator.”  By so doing, the Treasury Department would then be required under U.S. law to enter expedited negotiations with China to reduce our trade deficit with them and to eliminate any currency advantage. 

As you can imagine, as reported in the above linked article, the Chinese are reacting with horror.  The loss of their trade surplus with the U.S. is China’s worst nightmare.  They are utterly dependent on their exports to gainfully employ their vast over-supply of labor.  Without these jobs that have been taken from the U.S., unemployment would soar to depression-like levels and likely cause widespread civil unrest and violence in China. 

This is a clear indication that Obama plans to get serious about the trade deficit.  That’s the good news.  Very good news.  However, the tactic of branding China a currency manipulator is a rather crude way to go about it because currency exchange rates have very little to do with the trade deficit.  The huge disparity in population density between the U.S. and China (and many other trading “partners”) is a much more powerful factor.  When expressed in per capita terms (divided by the population of the nation in question), our trade deficit in manufactured goods with China is quite run-of-the-mill.  In 2006, there were eighteen other nations with whom our trade deficit was worse.  For example, our per capita deficit with Ireland, a nation twice as densely populated as the U.S. and number one on the list, was 25 times worse than that of China.  The per capita deficits with Japan, Germany, Korea, Taiwan, Switzerland, Israel, Austria, Denmark and Mexico, among others, all much more densely populated that the U.S., were all worse than China’s – most of them much worse. 

So why single out China?  Our trade results with China are exactly what we should have expected when we applied to them the same trade policy that was already a proven failure in all these other nations.  The sheer size of the deficit with China, which dwarfs the deficits of these other nations, which is what gets everyone’s attention, is just a function of them having one fifth of the world’s population. 

If we’re going to effectively address the trade deficit, it has to be done in a way that addresses the root cause.  Of our top twenty per capita trade deficits in manufactured goods, only seven are with relatively poor countries.  Many are with countries that no one ever accuses of currency manipulation.  But eighteen of these top twenty deficits are with nations much more densely populated than our own.  So I’m not saying that there aren’t other factors at work, but population density is the 800-lb gorilla in the room. 

What’s needed is a tariff structure for manufactured goods that is indexed to population density, leveling the playing field by extracting compensation from those nations whose over-crowding renders them incapable of offering us access to markets comparable to ours.  Any other approach that’s based on faulty logic is going to appear arbitrary and may put us in an indefensible position when challenged by others sympathetic to China.

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