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Trade deficit, China's currency require U.S. action now

By Peter Morici
web posted April 19, 2010

The Commerce Department reported the February deficit on international trade in goods and services increased to $39.7 billion from $37.0 billion in January. President Hu Jintao has told President Obama that China will not revalue its currency in response to U.S. requests.

This leaves President Obama with the difficult choice between acting unilaterally or appeasing Chinese mercantilism to the great detriment of U.S. businesses and workers.

Subsidized manufactures from China and petroleum account for nearly the entire deficit, and both will rise as consumer spending and oil prices rise through 2010.

China's refusal to stop undervaluing its currency, along with congressional Democrats' resistance to development of domestic oil and natural gas resources are choking the economic recovery. In turn, these reduce tax revenues and will require draconian cuts in federal, state and local government budgets or new taxes more burdensome than borne by major competitors in Europe, Japan and China.

At 3.1 percent of GDP, the trade deficit subtracts more from the demand for U.S.-made goods and services than President Obama's stimulus package adds. Moreover, Obama's stimulus is temporary, whereas the trade deficit is permanent and growing again.

Money spent on Chinese coffee makers and Middle East oil cannot be spent on U.S.-made goods and services, unless offset by exports.

When imports substantially exceed exports, Americans must consume much more than the incomes they earn producing goods and services, or the demand for what they make is inadequate to clear the shelves, inventories pile up, layoffs result, and the economy goes into recession.

To keep Chinese products artificially inexpensive on U.S. store shelves and discourage U.S. exports into the Middle Kingdom, China undervalues the yuan by about 40 percent.

Beijing accomplishes this by printing yuan and selling those for dollars to augment the private supply of yuan and private demand for dollars. In 2009, those purchases were about $450 billion or 10 percent of China's GDP, and 28 percent of its exports of goods and services.

In 2010, the trade deficit with China is reducing U.S. GDP by more than $400 billion or nearly three percent. Unemployment would be falling rapidly and the U.S. economy recovering more rapidly but for the trade deficit with China and Beijing's currency policies.

Longer term, China's currency policies reduce U.S. growth by one percentage point a year. The U.S. economy would likely be $1 trillion larger today, but for the trade deficits with China over the last 10 years.

China has indicated it will not revalue its currency at this time. Some analysts expect only a gradual revaluation if any change in policy occurs—perhaps a few percentage points a year. Such a move would have little consequence for the U.S. trade deficit, unemployment and growth.

China views its exchange rate policy as a tool of domestic development strategy but its policy has broad, aggressive and negative international consequences—it is choking growth and imposing unemployment on the United States and other western countries.

Diplomacy has failed, and President Obama should impose a tax on dollar yuan conversions in an amount equal to the amount of China currency market intervention divided by its exports—currently that would be about 28 percent. For imports, at least, that would offset Chinese subsidies that harm U.S. businesses and workers.

Ultimately, the amount of the tax would be in China's hands. If Beijing reduced currency market intervention and let the yuan appreciate, the tax rate would fall. If Beijing stopped intervening, the tax would go to zero.

Diplomacy has failed for both Presidents Bush and Obama.

American failure to take strong broad actions now would allow Chinese protectionism to wholly disrupt the free trade system facilitated by the World Trade Organization, undermine U.S. and European prosperity, and ultimately burden U.S. broader foreign policy objectives

American failure to act would amount to no more than appeasement, and wholesale neglect of President Obama's obligations to ensure U.S. economic security and sovereignty. ESR

Peter Morici is a professor at the Smith School of Business, University of Maryland School, and former Chief Economist at the U.S. International Trade Commission.

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