Trade Policy Stupidity on Parade

December 12, 2009

Friday we were treated to a rare display of trade policy stupidity from both sides of the aisle in Congress, with each party opting for different but equally flawed approaches.  As reported in the first Reuters article (link provided above), Senator Reid has sent a letter to Chinese president Hu Jintao, begging him to un-peg the yuan from the dollar in the hope that such a move will correct the trade imbalance between the U.S. and China. 

“I know China is committed to moving to a free floating currency eventually. But China’s currency policy has been causing major distortions in the world economy for too many years already, and is continuing to do so now,” Reid, a Democrat, said in a December 9 letter released on Friday.

“In the mean time, I hope you would consider a significant revaluation to bring the value of the RMB in line with economic fundamentals, and after that, to return to a more robust version of the ‘managed float’ that your government previously maintained,” Reid said.

But, as is always the case in U.S. trade negotiations, we’re all bark and no bite:

Reid stopped short of threatening U.S. legislative action, but warned that “the one-way nature of the imbalances in our economic relationship is a major factor causing Americans to question the efficacy of our trade policy.”

This focus on currency valuation as the root cause of our trade deficit with China is just dumb.  First of all, if currency valuations are the problem, why are we not also demanding that Japan revalue the yen?  After all, in per capita terms (that is, relative to the size of the country), our trade deficit with Japan is four times as large as the deficit with China.  Why are we not criticizing the EU (European Union)?  Our per capita deficit with the EU is almost exactly the same as our deficit with China!  If we’re going to blame our problems on currency valuations, shouldn’t we at least be consistent?

But, secondly, currency valuations aren’t the problem.  The evidence doesn’t support a relationship between currency valuations and trade imbalances.  Two years ago, China did revalue the yuan by 20% vs. the dollar and, instead of falling, our trade deficit with China actually widened.  Since the 1970s, the dollar has fallen by over 300% vs. the Japanese yen.  Yet, instead of falling, our trade deficit with Japan exploded.  More recently, in the past year, the dollar has fallen dramatically vs. both the yen and the euro.  But there’s been no change in price for products imported from these regions.  If anything, Japanese automakers have actually been cutting prices. 

While it seems logical that trade imbalances should ultimately be resolved by currency revaluation, it doesn’t happen because badly overpopulated nations, utterly dependent on exports to sustain their excess labor capacity, overcome the effects of a strengthening currency by cutting costs, by subsidizing their manufacturers … doing anything and everything to maintain their trade surplus. 

Not to be outdone, on the same day, along come the Republicans, oblivious to what the blind application of free trade has done to us, pushing a trio of free trade deals, two of them benign while one is sure to be another disaster.

Republican U.S. congressional leaders urged President Barack Obama to work with them to win approval of long-stalled free trade pacts with Colombia, Panama and South Korea as early as possible in 2010.”We agree with you that these trade agreements provide important new commercial opportunities that will benefit our economy and create jobs without adding to our nation’s staggering budget deficit,” House of Representatives Republican leader John Boehner and three other top Republicans said in a letter to Obama sent late on Thursday.

“We ask that you jump-start the implementation process through your leadership, particularly by promoting all three of these pending trade agreements when you speak to the nation in your State of the Union address,” they said, referring to an annual speech to Congress usually in late January.

Colombia and Panama?  No problem.  We have a nice per capita trade surplus in manufactured goods with both countries.  Why?  Not because of a favorable currency valuation, but because the population density of both countries is about the same as our own. 

South Korea is an entirely different matter.  With a population density fifteen times that of the U.S., it’s no wonder that we have a per capita trade deficit in manufactured goods with South Korea that’s almost double that of China.  Why in the world would we want to repeat the same mistake with South Korea that we’ve made with so many other badly overpopulated nations?  Will we start complaining about South Korea’s currency valuation as soon as such a deal is signed?

Such inconsistent trade policy that’s rooted in theories not supported by the facts is just stupid, and the application of such stupid trade policy for the past several decades has driven us to the brink of economic collapse.  We may yet arrive at the point where Congress begins imposing tariffs to restore a balance of trade but, without an understanding of the role of population density and the accompanying rationale for the use of tariffs, it will be perceived as random, arbitrary and vengeful, and will likely make a complete mess of global trade.  But, then again, from the perspective of the U.S. economy, it couldn’t really be any worse.