Starting a trade war isn't the answer to Chinese currency manipulation

Mar 15 2010

Paul Krugman, in the New York Times, argues that China's manipulation of its currency should be tackled by imposing a 25 per cent tariff on their goods until they revalue their currency, the renminbi:

"But if sweet reason won’t work, what’s the alternative? In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. At this point, it’s hard to see China changing its policies unless faced with the threat of similar action — except that this time the surcharge would have to be much larger, say 25 percent.

I don’t propose this turn to policy hardball lightly. But Chinese currency policy is adding materially to the world’s economic problems at a time when those problems are already very severe. It’s time to take a stand."

Irwin Stelzer made a similar argument in an article for CBS News.

The strategic risks that we would run by doing something this provocative are significant. The Chinese see manipulating the renminbi, to strengthen their export industries, as extremely important. They're doing it to create the vast number of new urban jobs they see as necessary to employ the massive number of migrants currently heading into their rapidly growing cities. Anything which hinders that they will take as a threat to their regime's stability. If unemployment grows then the Chinese leaders are going to start feeling very insecure and that will make the world a much riskier place.

And there would also be a price to pay at home. After all, what the Chinese are effectively doing is intervening in the markets to reduce the price that Western consumers pay for Chinese goods. That hurts our businesses who find it harder to compete with Chinese exporters. But it benefits British families who get a huge range of consumer products at a low price, which eases the burden on their budget significantly. Would you want to see the price of everything you buy that is Made in China go up?

Pushing up the price of consumer goods will in turn make it harder to get the public finances under control. Anything that adds to the burden on ordinary families will make it harder for them to deal with a fiscal adjustment, whether it comes through spending cuts or tax rises.

Britain and the United States and the Chinese have an interest in dealing with the overvaluation of the renminbi gradually. If the Chinese stop intervening to keep the value of the renminbi down then that will improve living standards for the great mass of Chinese people, and jobs can be built more on domestic demand than producing for European and American markets. In the long term it isn't sustainable to have their economy dependent on an artificially weak currency. We need to work to convince them of that. Giving up on convincing them, and instead taking aggressive action through tariffs, will be very risky, hurt consumers here and undermine our attempts to get the deficit under control.