Friday, March 26, 2010

Threading the needle on China and currency manipulation.

There's been an ongoing debate about China and its currency manipulation. I'm not going to try to recreate the entire argument here, I think some of the main posts are Paul Krugman's, those on Free Exchange (link only to most recent, many more in the last couple weeks), and most recently DIA. In short form the discussion is about whether, and if so how, the US should respond to China's currency manipulation.

My position on this is basically two part. I agree with Krugman that China's currency manipulation is a problem but I think it is difficult to do anything about it. The problem with taking action comes from several areas. First, it is common to overstate what you can do with power and I don't think this is a situation where the exercise of power will have an effect. This is a subject that should probably have its own post, I'll get around to it when I have time. Second, I think the political dimension isn't being given enough attention.

There are two parts to this as well. First, there is a lot of evidence that there is already a debate in China about revaluation. Second, the Chinese government has a lot more to consider with this than just the economics. The government seems primarily concerned with stability as well as its own legitimacy. Currently, China is relying on rapid economic growth to maintain both. It isn't so long ago however that it relied on other methods. US pressure would give the Chinese government a strong incentive to consider the potential benefits of a nationalist response to maintain its popularity and to present itself as a leader and potential alternative to US hegemony. It would rightly be reluctant to be seen as caving in to US pressure, as would any country.

This leads to a conundrum. We need to apply pressure but do so in a way that does not give China a potential political advantage. There are two ways of doing this. The first, is to start being unhelpful to China in other areas and to launch other diplomatic initiatives that pointedly leave China out of the picture. Then gently make clear that if they want to play in these areas, they need to play the currency game too.

The second idea was inspired by this DIA blog post and the linked paper. Given that currency manipulation is not currently against WTO rules this provides us with an opening to apply pointed pressure without direct confrontation. I don't know enough about the internal workings of the WTO to give the precise mechanism to engage but we should use its formal mechanisms to either inquire about a formal ruling on how the WTO would treat currency manipulation if a case were brought or circulate the idea among WTO members that we intend to bring up currency manipulation as an area that we wish formal rules to be drawn up for. This avoids the problem of risking a trade war with China while making it obvious that we are serious about this and it is not just rhetoric in Congress asking for the revaluation.

Of course, getting this done requires someone in a position to do something about this reading this blog (and not already having thought of this) but this seems to me the most realistic way to apply pressure without risking the very expensive downsides.

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