Protectionist Threats

The protectionist threats are getting louder. Unless China changes its practices immediately, Senators Schumer and Graham are calling for a vote on their bill to impose a temporary tariff of 27.5% on all imports:

Play by the Rules, by Charles E. Schumer and Lindsey O Graham, Commentary, WSJ: If there's one issue on which we all should agree, it is that increasing global trade is good for American workers and businesses. No serious economist believes that we would be better off if we closed our borders. But for trade to be good for our people, every major economic power needs to abide by the rules of free trade.

One of the fundamental tenets of free trade is that currencies should float -- or at the very least, move along with market forces. The reason for this is that a free-floating currency allows large trade imbalances to self-correct... Unfortunately, the Chinese government intervenes in the market to keep its currency, the yuan, artificially low, which allows China to artificially inflate its exports and reduce its imports. Their continued manipulation is a form of protectionism, and it throws the whole global trading system out of balance...

China bends or breaks the rules far too often. Years of currency manipulation, intellectual property theft, and barriers to entry have cost American jobs and contributed heavily to our trade deficit with China... China's actions ... make it harder for Americans to support free trade...

Three years ago, we grew frustrated with the pace of China's reforms, and we introduced a bill that would impose a temporary tariff of 27.5% on all Chinese imports unless China agreed to play by the rules. Our bill was carefully crafted to not impose tariffs immediately, giving the parties time to negotiate an alternative. In addition, the president would retain the right to delay the tariff for up to two years. Neither of us wants the tariff to become law; our goal all along has been to send a shot across China's bow and prod them to play fair...

Senior administration officials concede that our bill has helped strengthen their hand in negotiations. So we have succeeded in getting China's attention. In fact, we believe the only reason there has been any progress on this issue at all is because of the existence of our bill...

In April 2005, we finally brought our bill to the Senate floor. The Chinese responded that July by allowing the yuan to appreciate by 2.1%, and promising to allow market forces to play a greater role in determining its value. Since the small revaluation, however, the currency has appreciated very little in 14 months... So the rhetoric out of China is not being matched by real results.

We have agreed four times since last April to delay taking a final vote on our bill. Before the most recent delay, in March of this year, we traveled to China to meet with several of its top government officials... We returned from our trip with the strong impression that China would move more quickly in the ensuing months. However, ... there was no real movement.

We appreciate that China's banking system is not yet ready for a fully floating currency, but we also agree with most mainstream trade economists that gradual currency appreciation is possible without disrupting their "harmonious society." We have been patient and reasonable, but the time for patience has run out. The workers and manufacturers in our states rightfully demand a level playing field...

Unfortunately, the Chinese appear to be content with the status quo... They have no reason to change unless we send a very strong message that the status quo is not acceptable.

We look forward to meeting with Treasury Secretary Hank Paulson, who just recently returned from China. We hope he brings back good news. If not, the clock will have run out and it will be time for an up-or-down vote. With Congress's recess imminent, we know our bill will not become law, but it will be our last opportunity before a new Congress convenes to send such a message. We believe more strongly than ever that pressuring the Chinese to allow their currency to float is in the economic interests of both nations.

My guess is that China will say the right things, then do what it was going to do anyway. Hopefully, whatever happens, protectionism can be avoided -- that's a downward spiral for all. But if the yuan is devalued revalued significantly, a previous post (slightly edited) summarizes what might happen. We shouldn't expect any miracles in the short-run:

1. Consumers are worse off due to the rise in the price of consumer goods. If revaluation is bilateral and production moves from China to other countries, this effect may not be as large in the long-run. If the dollar devalues against other currencies generally, the effect on prices paid by U.S. consumers will be larger.
2. Borrowers (households, business, and government) are worse off due to rising interest rates which increases the cost of loans and the cost of financing government debt. Part of this is a transfer from borrower to lender, but there is a net drain as well due to debt held by foreigners.
3. U.S. manufacturers are better off, but this requires the dollar to devalue against other currencies generally, not just against a particular currency such as the yuan.
4. If U.S. manufacturers do better, then employment will increase as well making labor better off, but this takes time to occur.
5. If employment and manufacturing do increase, there are transitional costs to consider. Rising interest rates will cause less activity in sectors such as housing and more activity in other sectors such as (hopefully) computer chips. Thus, during the transition unemployment could increase. Nevertheless, to the extent that such domestic and international rebalancing is healthy for the economy in the long-run, there is a long-run benefit that more than offsets the short-run cost.

Update: I didn't cover this aspect, but Greg Mankiw and KNZN (the latter more completely) evaluate the statement "One of the fundamental tenets of free trade is that currencies should float."

Update: William Polley has the latest, "But it does keep their name in the papers...":

Senators Schumer and Graham may be standing down... for now...