From George Gilder's column in today's Wall Street Journal,
Meanwhile, Secretary of State Hillary Clinton and the president's friends at Google are hectoring China on Internet policy. Although commanding twice as many Internet users as we do, China originates fewer viruses and scams than does the U.S. and with Taiwan produces comparable amounts of Internet gear. As an authoritarian regime, it obviously will not be amenable to an open and anonymous net regime. Protecting information on the Internet is a responsibility of U.S. corporations and their security tools, not the State Department.
The full column is here
Should antitrust enforcers be concerned about entry barriers in the search ad market? Some believe the market exhibits "network effects," according to the New York Times.
Although traditionally applied to Industrial Age industries with high fixed costs like railroads and telephone exchanges, anything now exhibits a network effect if its value increases because more people use it. Network effects are "everywhere," according to a top former antitrust official. Coke and Pepsi drinkers, for example, "benefit from the network of their fellow consumers because Coke and Pepsi are widely available in restaurants and in vending machines," claims Timothy J. Muris.
A preexisting network of vending machines is admittedly tough for soft drink imitators to replicate. But a barrier to imitation can also be viewed as a spur to innovation because it acts as a reward which inspires creators and investors. Not an incentive to create a barely distinguishable alternative, to be sure, but to create something transformative.
The alleged network effects in search advertising are more subtle than in the case of railroads, telephone exchanges or soft drinks (in fact, they even bear a striking resemblance to what one might term legitimate and hard-won competitive advantages).
[E]conomists and analysts point out that Google does indeed have network advantages that present formidable obstacles to rivals. The "experience effects," they say, of users and advertisers familiar with Google's services make them less likely to switch. There is, for example, a sizable cottage industry of experts who tailor Web sites to get higher rankings on search engines, which drive user traffic and thus ad revenues. These experts understandably focus their efforts on the market leader, Google -- another network effect, analysts say.
This sounds remarkably like how the European Union sees
the market for streaming media players. The EU prohibits Microsoft from including a free player with its PC operating system because its competitors couldn't give away enough copies of their own media players.
Network effect theory overlooks whether, perhaps, there are no other objective differences in the value propositions of the competing products. If consumers have a choice between a superior product versus an inferior product which most of their neighbors are using, the theory assumes most consumers will choose the latter. Thus, there is no incentive for anyone to design a superior streaming media player for a desktop PC.
But that may not be a bad enough thing to warrant letting politicians and bureaucrats rearrange the market. It is inherently destructive to innovation to allow them to do that, because they principally serve constituencies who are more interested in preserving the status quo.
Picking up on Braden Cox's recent post over at Technology Liberation Front, "Abuse of Power? Competition Commissioner that Pushes 'Smart Business Decisions,'" it's no secret that Europe's software industry is years behind Microsoft, and not surprising the industry is seeking help from politicians in Brussels. When Kroes, a politician, talks about open standards one must assume she is referring to the European software industry, not to the open source movement generally. Of course, for the moment "the enemy of my enemy [may be] my friend," as they say.
In her remarks last week Kroes said,
"I know a smart business decision when I see one -- choosing open standards is a very smart business decision indeed," Ms. Kroes told a conference in Brussels. "No citizen or company should be forced or encouraged to choose a closed technology over an open one."
This statement could be read either as an innocent statement of personal opinion, or more like an informal, unofficial statement of official policy with plausible deniability. I suspect it is the latter, and that if you are a European bureaucrat or business leader you now understand what is expected of you as far as your future software procurement is concerned.
Why would Kroes need to be opaque? Because there are both structural (e.g., excessive tariffs, unreasonable licensing terms, etc.) and nonstructural trade violations (e.g., certain winks and nods) which are actionable. And because two or more can play this game.
A good reason for governments to not encourage boycotts of foreign goods is because foreign governments can do the same thing.
That can lead to trade war, in which your efforts to protect one of your small, insignificant struggling industries may result in foreign retaliation against your most successful exporters.
Trade wars don't always have serious repercussions, but they have sparked global recessions and many think a trade war sparked the Great Depression.
That's another good reason why maybe politicians on both sides of the Atlantic ought to leave software procurement decisions up to the marketplace.
The Chinese have a big trade surplus with us. But as I noted yesterday, the U.S. has a massive worldwide profits surplus. Which would you rather have?
James Fallows of The Atlantic is now living in Shanghai and points to a recent study that makes this point in a concrete way. Richard McCormack of Manufacturing & Technology News summarizes here a new study of the components of an iPod, showing the revenue and profit margins of the various vendors and the desinger and seller of the iPod, Apple. The Personal Computing Industry Center found that on the $299 Video iPod Apple's gross margin was $80, with revenue of $30 going to distribution and $45 to retail. That's more than half the retail price. Dozens and dozens of other companies supplying endless components make up the other half of the sale price. But their profit margins are far lower than Apple's, and furthermore, many Japanese, Korean, and Taiwanese components (often themselves designed with help from American engineers) flow through China in final assembly and on to America, where they add to our trade "deficit" with China and China's trade "surplus" with us. Yet these very transactions lead to a Chinese trade "deficit" with the rest of Asia. Maybe these trade statistics are all just a big smoke-screen.
As the PCIC concludes:
"Trade statistics can mislead as much as inform....For every $300 iPod sold in the U.S., the politically volatile U.S. trade deficit with China increased by about $150 (the factory cost). Yet, the value added to the product through assembly in China is probably a few dollars at most. While Apple's share of value capture is high for the industry, the iPod's overall pattern of value capture is fairly representative.
"Today, no single country is the source of all innovation and therefore U.S. companies need to work with international partners to bring new products to market. These companies will capture profits commensurate with the extra value they bring to the table. This is simply a fact of business in the 21st century and the good news is that many American companies are winning this game and continuing to bring significant benefits to the U.S. economy."
Many politicians want to legislate away the trade "deficit" with Asia. What they effectively seek is the abolition of the U.S. surplus in innovation, captial, profits, and jobs.
EUROCHAMBRES, the association of European chambers of commerce, has a new report out measuring the EU's progress achieving its ambitious plan of becoming "the most dynamic and competitive knowledge-based economy in the world capable of sustainable economic growth with more and better jobs and greater social cohesion, and respect for the environment." Unfortunately, the report concludes that the EU is still losing ground.
In two years' time, the gap EU-US (sic) has widened for all economic indicators:
Income (GDP per capita). The current EU level for income was achieved by the US in 1985. Since the first edition of the study, the time gap has increased by 3 years;
Employment and R&D. Both the current EU levels for employment and R&D investment per capita were reached by the US in 1978. (+3 years and +5 years respectively);
Productivity (GDP per employed). The current EU productivity level was achieved by the US in 1989 (+3 years).
The current EU level of Internet users per capita was reached by the US in 2002. The gap for this indicator was assessed for the first time in this edition of the study.
European leaders are attempting to overtake the U.S. without cutting taxes or reducing regulation. That's what they mean when they talk about sustainable
economic growth, social cohesion
for the environment. I hope they're successful, but I fear they've set unrealistic goals and will continue to punish innovative American companies as a result. After accusing Microsoft of market dominance for commanding a mere 34% of the server market in the aggregate, European Union regulators have turned their attention to other successful American companies. Qualcomm, which offers discounts on bundled products, and Intel, which offers volume discounts, are both under investigation as a result of complaints the EU has received from American and European competitors. This is because the current generation of European leaders, like their mercantilist forbears, possess a vision of finite possibilities in which one country's success comes at the expense of another's. At least that's how I interpret the following passage from a high-level report
prepared by the EU in 2004:
Europe has to develop its own area of specialisms, excellence and comparative advantage which inevitably must lie in a commitment to the knowledge economy in its widest sense -- but here it is confronted by the dominance of the US. The US threatens to consolidate its leadership. The US accounts for 74 % of top 300 IT companies and 46 % of top 300 firms ranked by R & D spending. The EU's world share of exports of high-tech products is lower than that of the US; the share of high-tech manufacturing in total value added and numbers employed in high-tech manufacturing are also lower. In a global economy, Europe has no option but radically to improve its knowledge economy and underlying economic performance if it is to respond to the challenges of Asia and the US.
In fact, "economic integration runs deep," as the EU commissioner for the internal market and services, Charlie McCreevy, noted this week in a Wall Street Journal column comparing Sarbanes-Oxley to the Europe's more cautious approach in regulating financial markets. The EU resisted the temptation to impose Sarbanes-Oxley regulation and this is a key reason their capital markets are thriving and outperforming ours as a result. Some Europeans are celebrating, but McCreevy pointed out "anything that hurts U.S. capital markets also hurts European companies and our economy." That's how the U.S. and the EU need to view antitrust and competition policy. Since we're economically integrated, anything that harms innovation on one side of the Atlantic hurts companies and the economy on the other side. And obviously the reverse also must be true.
David Malpass of Bear Stearns has, not surprisingly, written the best article on the "trade deficit." Malpass, along with George Gilder, Ken Fisher, and I, agree that the U.S. needs more debt, not less, in both our trade and domestic budget accounts.
Malpass explains how the trade deficit is actually a capital surplus, why we will never have to "pay back" these supposed debts, and why the U.S. is not "squanderville" but a haven for capital-hungry growth and innovation:
Like young households, many companies also spend more than they produce, using bonds and bank loans, some from foreigners, to make up the difference. They add employees, machines, supplies and advertising before they produce. Growing corporations are expected to be cash hungry. This leverage is treated as a positive for companies but a negative for countries, a key inconsistency in popular economics. Rather than paying the debt back, the growing company rolls the debt over and adds more, just as the U.S. has been doing throughout most of its prosperous economic history. Part of each additional bond offering puts the company and the U.S. in the position of investing more than we save, drawing in foreign investment and contributing to the trade deficit.
Are you listening Sen. Schumer? Sen. Graham? Mr. Buffett? Anyone there?
Former Bush economic advisor Larry Lindsey wrote a great book on taxes , and he helped design the excellent 2003 tax-cuts, right before he was asked to leave the White House. But on monetary policy, Larry Lindsey looks more like famed protectionist Lindsey Graham.
In today's Wall Street Journal, Lindsey uses the occasion of Chinese President Hu Jintao's upcoming U.S. visit to make the case for a forced appreciation of the Chinese yuan. Where to begin?
- Lindsey writes that China wants the government to set monetary policy but the U.S. wants "the market" to set monetary policy. This is curious given that our Federal Reserve, not "the market," has monopoly control over the money supply.
- Lindsey argues that it is China's too-cheap yuan that allows Americans to "over-consume" Chinese goods and China to "over-invest" in U.S. assets. Lindsey argues that a relatively stronger yuan would reduce American consumption and Chinese investment and thus reduce our trade deficit. But Lindsey ignores one of the fundamentals of classical economics: You cannot change the terms of trade by changing the unit of account.
- Robert Mundell, winner of the 1999 Nobel prize in economics, explains it this way: the U.S. trade gap with China is not a monetary phenomenon. It is a real phenomenon. It is the result of a real competitive shock from the huge Chinese labor supply and rapidly rising Chinese productivity, creativity, and sophistication.
- Lindsey presumes to know how "the market" would value the Chinese currency. "The Chinese clearly undervalue their exchange rate," he writes. But exchange rates are dependent on the monetary policies of the various central banks that determine the values of currencies. Exchange rates are fluctuating all the time given the policies of governments. Divining a permanently higher value of the yuan is based on what?
- If a decade ago China had fixed its yuan at 4 to the dollar instead of 8.28 to the dollar, there would have been some severe adjustments internally in China back then. But the trade relationships with the U.S. and the rest of the world would be exactly the same today. Repeat, this is not a monetary phenomenon. Pretending that a change in the exchange rate will in any way help the U.S. by reducing our trade deficit is wrong...and harmful because it takes our eye off the ball of important policies that actually could make us more competitive in the global economy.
- Lindsey seems fatalistic about the prospect of protectionist legislation in Congress and says we should make a currency deal now to head off such self-destructive nonsense. But I think this strategy lets Congress off the hook way too easily and continues to give cover to numb-brained protectionists who should instead be ignored or directly confronted.
- Lindsey argues that the dollar-yuan link has reinforced "communist control." But by greatly expanding commerce inside China and trade with the rest of the world, the stable currency policy has dramatically boosted the private sector in China and thus substantially reduced "communist control."
- All this said, I wouldn't mind a 10-15 percent appreciation of the yuan versus the dollar--but NOT for any of the usual stated reasons. It seems to me our Fed is running an inflationary monetary policy, highlighted by the near-$600 price of gold. A slightly stronger yuan would help China fend off some of the inflation they are importing by virtue of their dollar link. But there is absolutely no reason the yuan should forever be "stronger" than it is today. If China fixed to the dollar at much stronger terms, and then the Fed strengthened the dollar, it would push China into deflation, with very bad consequences for them and us. But even after the painful adjustment process, the fundamental trade gap would exist. Dollar stability and yuan stability are the ultimate goals, with or without the dollar-yuan link.
The rise of China is a real economic event. Not a monetary trick. Tricking ourselves into thinking we can solve this non-existent problem through exchange rate manipulation merely diverts us from important economic reforms here at home.
As Chinese computers come under fire here in the U.S., Sens. Chuck Schumer and Lindsey Graham are in China eating some crow (sub. req.). Suggesting that maybe their blunt approach of a 27.5 percent tariff on China is less than optimal, Graham says, "I am more sensitive now than I was before to how hard it will be to move toward a floating currency," and Schumer offers, "We are more optimistic that this can be worked out than we were in the past. But whether it will be, we're not certain yet."
When you consider how easy it was for two Senators with no economic knowledge and who had never set foot in China to gain so much traction with such a potentially disastrous proposal, you cringe. Then again, maybe reason is finally coming to the fore and we should just be thankful.
What a mindnumbingly senseless precedent the Dubai Ports World fiasco has set.
This time around it's the State Department's purchase of 15,000 "Think Pad" computers. "What's wrong with that?" you might ask -- "I've got a Think Pad. IBM, right?" Ah, but a year ago, IBM sold its low-margin PC division, including its Think Pad line, to Lenovo Group of China -- scratch that, cue thunderclaps and witch cackles, Lenovo Group of Red Communist China. The $13 million worth of PCs, you see, are therefore now a probable effort to spy on our diplomats. At least two members of the U.S.-China Economic & Security Review Commission, including its chairman, Larry Wortzel, are worried and think you should be worried, too. "Members of Congress, I think, will react very strongly when they see a deal like this come through," Wortzel says. His Commission colleague, Michael Wessel, warns, "The opportunities for intelligence gains by the Chinese are phenomenal."
With trillions of dollars of international trade, you can see this protectionist paranoia will never end. They say our port security will be corrupted, our PCs will be tapped, and that the Barbie Dolls and DVD players on Wal-Mart shelves are destroying America. In my homestate of Indiana, we barely just turned back a xenophobic melee over the bid by ominous Australians to manage our Toll Road. This won't end -- unless we put a stop to the hysteria -- now.
Correction: the Lenovo PCs in question are not "Think Pad" laptops but "ThinkCentre" desktops and tower PCs.
Two items in today's Wall Street Journal "Washington Wire" indicate the Administration might be wising up on the free trade front. Ambassador Karan Bhatia, who is off on a five-nation Asian trade mission, commented from Manila:
"Political support for free trade is weaker than it has been in many years," he said, citing "the recent public discussion in the United States on the issue of foreign investment," alluding to the uproar over a Dubai investment in U.S. port operations as well as U.S. skepticism about China and the Central American Free Trade Agreement. "In a way we have not seen for years, economic isolationists on both ends of the political spectrum are reasserting themselves."
Maybe the Dubai Ports fiasco really did splash cold water on the White House's face and wake them up to the building hyper-nationalist and protectionist sentiments for which they themselves must take some blame.
On that front, Treasury officials are now said to be leaning against labeling China a "currency manipulator," which they rightly suspect would further inflame and enable protectionists in Congress. Even considering such an erroneous policy has given cover to economic imbeciles and their dangerous legislative proposals. Speaking of, Sens. Schumer and Graham are leaving for a weeklong trip to China, said to be Schumer's first official foreign trip in his 25-year Congressional career. We hope they learn something about the wider world.
What's going on? Last week the U.S. Trade Representative Rob Portman unveiled a comprehensive review of U.S.-China trade relations and our policy toward the Middle Kingdom. The report acknowledges the many benefits that flow from trade with China. It also announces new steps to strengthen our ability to monitor and affect China's compliance with intellectual property laws and WTO rules. So far, so good. The report even stays away from the contentious issue of the supposedly undervalued Chinese currency, the yuan. The word "yuan" is not even mentioned in the long report. I thought this was a real breakthrough in U.S. policy toward China, showing a more nuanced and sophisticated view of the relationship, one that might actually get results in the areas where China actually is doing some harm, like IP. The free-traders at the U.S. Chamber of Commerce hailed the report.
Then today on the front page of The Wall Street Journal's website, we see that the U.S. Treasury is contemplating -- yet again -- labeling China a "currency manipulator." (See more here and here.) Such a label would set off a chain of events of special reports and meetings to decide what to "do to China" for the sin of outsourcing its monetary policy to our Federal Reserve. Worse, such a label would fan the already spreading flames of protectionism in the U.S. Congress, where lawmakers toss around catastrophic proposals for 27.5% tariffs as if they are only a little more consequential than earmarks or pork.
It seems last week's USTR report may not have been the inauguration of a new, smarter China policy, as I had thought, but the opening salvo of a new anti-China campaign ahead of President Hu Jintao's April U.S. visit. Surely, dangling the "manipulator" label out there could be a negotiating strategy, but as we all know, sometimes bluffs get called. Then what? This is the dangerous path that could lead to a trade war. I suppose some of this has even been pre-negotiated with Beijing -- we drop the "manipulator" label in exchange for better IP enforcement -- but even so, the constant erroneous suggestion by our Treasury that China is stealing wealth from the U.S. using a clever currency trick does great harm by giving credibility to the arguments of the protectionists. If policymakers believe the yuan is too weak, then they must understand the dollar is similarly weak. If they think the Chinese currency is being "manipulated," they should look to the group conducting Chinese monetary policy, namely Alan Greenspan and now Ben Bernanke.
This is a risky high-wire act. It could be madness. I hope we know what we're doing.
Nobel prize winner and China expert Robert Mundell continues to be optimistic about the Chinese economy but now also believes the U.S. has stepped down its intense pressure to appreciate the Chinese yuan. Good news all around.
China today announced a large $102 billion trade surplus for 2005, triple last year's total. But wait. Excluding its $114.7 billion trade deficit with the United States alone, China actually ran a modest trade deficit of almost $13 billion with the rest of the world. We've been predicting this development all year. China's consumption of consumer and capital goods is growing fast. According to a recent "economic census," the nation's first ever, its domestic services economy is one-third larger than previously thought and accounts for over 40 percent of GDP. These numbers are just one more factor showing that China has not been "manipulating" its currency, the yuan, to gain unfair advantage in international markets via a singular focus on manufacturing exports.
When the biggest two news items during President Bush's China trip were his bike ride and his attempt to exit a locked door, it's clear any contentious conversations happened, well, behind that locked door. This is good news, especially on China's currency, the yuan. Both the U.S. and China reiterated their basic views, without directly contradicting the other side. President Bush said in his press conference with President Hu Jintao that "We'll continue to work with China to help implement its July commitment to a flexible, market-based currency." But Yi Gang, an assistant central bank governor, said that "China would keep the yuan basically stable...." The status quo of stable exchange rates is good for now, though at some point the U.S. will have to wise up, accept this arrangement (if not endorse it), and take a stand against the masochistic Schumer-Graham tariff legislation, which seems to rear its ugly head every other month.
Although Mao Zedong's presence still superficially dominates the main public space here in Beijing--his mausoleum at one end of Tiananmen Square and his portrait guarding the Forbidden City at the other--almost everything else in China's capital city refutes Mao's life, legacy, and ideas. Once ubiquitous, gray and brown Mao jackets have now been utterly replaced by a new national garment--colorful North Face ski jackets. The other place you'll see Mao is on all the money, known as yuan or renminbi, or simply RMB. Hundred-yuan bills, 50s, 20s, 10s, ones--it's all Mao. The irony is that Mao was not, shall we say, a terrific economist. Yet for the last 27 years, China's management of its economy and this massive transformation of the largest country on earth could hardly have been better. This includes, first and foremost, the stellar management of its currency, which endured a successful high-wire act of two price systems in the 80s--one for the old state-run economy and another for the new private economy--and then, in the mid-1990s, the linking of the yuan to the dollar. Another big success for China, the U.S., and the global economy.
In his visit last month, Treasury Secretary Snow lightened up publicly just a bit on his previous calls for China to float and appreciate the yuan by up to 30 or 40 percent, though many said he was still pushing hard behind the scenes. Incoming Fed chairman Ben Bernanke, in hearings yesterday that were otherwise somewhat encouraging, reiterated his view that a flexible, market-set exchange rate (read: possible Chinese deflation and international instability) was in China's best interest. We've been critical of Snow and Bernanke's views on this topic and will be watching and commenting during President Bush's China stay.
Word is the U.S. Trade Representative is prepared to capitulate to a South American country that wants to regulate mobile phone service like a state-owned monopoly. Colombia is pushing the plan, which flies in the face of all the available evidence that wireless is as competitive as you can get, and is contrary to recent Free Trade Agreements with Chile, Singapore and Central America.
Colombia wants language included in the Andean Free Trade Agreement defining CMRS as a "major supplier" that should be subject to confiscatory regulation that was in vogue at the FCC in the Clinton years. Bureaucrats at USTR reportedly like the idea.
The Wall Street Journal notes Monday that "U.S. Treasury Secretary John Snow struck a surprisingly conciliatory tone after talks with China's top economic leaders," and that his comments "seem to put to rest speculation that the administration of U.S. President George W. Bush might declare China a 'currency manipulator' in a coming report as many in Congress are demanding." This jibes with our view, expressed yesterday, that the chances of a continued high-intensity currency and trade battle have diminished.
also notes, however, that "Mr. Snow's new stance could draw increased opposition from Congress, where a number of lawmakers are threatening to impose large tariffs on Chinese imports unless Beijing lets the yuan appreciate more sharply." The Treasury and White House will now have to make forceful and convincing arguments to lawmakers who had been led too far down a protectionist path. Undersecretary Tim Adams says the U.S. will continue to hold China to its "public" promises of a currency change. But just what the Chinese have promised is unclear. Many Chinese officials say many things, but the most high-level and high-profile statement made so far by China is President Hu's endorsement on Friday of stable exchange rates.
Either way, John Snow appears to be buying the world economy a bit more time.
Has John Snow's China trip turned from expected blizzard to a light dusting instead? Secretary Snow and other U.S. Treasury officials in China are attempting to broaden their message beyond criticism of a supposedly undervalued yuan. Snow has spent the last few days urging China to modernize its financial, credit, equity, debt, and commodity markets. This is all fine advice, as far as it goes. China knows it must establish advanced financial institutions, markets, and services. It wants to do so. It is doing so. The process is already well underway, with functioning stock markets in Shanghai and Shenzhen, a new commodities market about to open in Shanghai, and rapidly developing consumer credit and mortgage markets. Of course, many interior agricultural areas are still very backwards. Snow also this week has been seeking greater market entry for U.S. financial and insurance companies. Again, this is welcome, if standard, rhetoric. If Treasury’s focus on Chinese market liberalization means less time to agitate over a yuan revaluation, so much the better.
Back in the U.S., however, an array of special interests is already calling Snow’s trip a failure
. The Schumers and unions on the left and the manufacturers on the right can see as well as anyone that China’s President Hu Jintao has committed to a stable currency policy (as I noted in yesterday’s post). They worry that Snow has shifted his message to focus on China’s domestic financial services market. The groups are intensely pressuring Treasury to label China a “currency manipulator” in its biannual report on the topic due out in early November. Sen. Schumer, who temporarily pulled his 27.5-percent across-the-board tariff legislation this summer at the personal and public request of Fed chair Alan Greenspan, says he will re-launch
his bid to tax all U.S.-China trade if China does not revalue the yuan.
Treasury’s shift in focus this week is welcome, but its earlier intense pressure for yuan revaluation fanned the flames of protectionist sentiment and legislation. Treasury either really did agree with the protectionists, or it egged them on for far too long. Maybe it was an ultra-clever negotiating position to bring back from China this week lucrative deals for U.S. firms. The strategy might partially work. But Treasury has still boxed itself in. The protectionists have gained far more support in Congress than anybody thought they could. In a surprising test vote this spring, the Senate gave more than 60 votes to Schumer’s tariff. Even Schumer was stunned, thinking initially his bill was just a sop to New York manufacturers. So Treasury’s indulgence of protectionist economic policy – whether a mistake or an overly clever ploy – has let popular myths fester and given hope to protectionists everywhere.
It now has three choices: (1) Capitulate to the protectionist lobby, and push forward with a weak-dollar/strong yuan currency policy, backed by threat of dangerous tariffs. (2) With cleverness and finesse, pacify the protectionists while doing as little harm as possible to the Pacific economic fabric known as the U.S.-China relationship. (3) With great courage, clear economic thinking, and pro-active communication, rebuff U.S. protectionists and stand up for free trade, capitalism, a growing China, and a prospering U.S. Number 1 appears a bit less likely today than it did a week ago. Number 2 will be tempting for all politicians, but Number 3 is important for the economy and for long-term global relations. A clear statement of currency stability and free trade will reduce monetary uncertainty, negate any chance of a trade war, and send a message to financial markets and to entrepreneurs that China and America are open for business.
U.S. Treasury Secretary John Snow is in China for a nine day visit. But which nation's leader is offering supply-side economic advice? If you guessed Chinese President Hu Jintao, you are correct. Citing evanescent "imbalances," Snow continues his calls for de-linkage of the yuan from the dollar and subtly still pushes for a major yuan appreciation. The U.S. thus inexplicably continues its weak dollar currency policy. Hu, on the other hand, believes that "All countries, major economies in particular, should keep major currencies reasonably stable and prevent trade protectionism." Bingo.
Over the past decade, the dollar-yuan link has been a key source of growth and stability not only for the U.S. and China but also across the global economy. China's trade policies have not always matched Hu's positive free trade rhetoric, but at least they have made their stance clear and can now be called to account. The U.S., however, damages its own free trade credibility when it muddies the waters with monetary protectionism and tariff threats. China is not likely to substantially revalue the yuan for a number of both internal and external reasons: an overly strong yuan would hurt not just the overall Chinese economy but especially its rural farmers in the country's interior, where Beijing is focused on improving incomes relative to the coast. Deflation would reduce commodity prices and thus farm income, exacerbating income differences with the fast-growing coastal free zones.
Money is a store of wealth, a standard of value, and a unit of account. Change its value, and you change every relationship across the economy. In the short run some will win and some will lose. But in the medium and long term, everybody loses. The value of money should not fluctuate freely at every arbitrary geographic border. In an economy, money and law should be stable. Everything else should be dynamic.
With a few days left in his Asian trip, hopefully Secretary Snow will second Mr. Hu's call for stable money and free trade.
President Bush's meeting with Chinese President Hu Jintao today in New York and their newly agreed-to meeting in November in China suggest China is on the White House radar, as it should be. Asian economic policy should be right at the top of the Washington's policy list (there's also this small matter of potential North Korean nukes). But why is the White House still obsessing over the "trade gap" with China, browbeating assurances out of Hu to reduce the trade gap by buying more American goods?
Where to start?
First, the trade gap is an accounting identity and implies a capital surplus. We buy lots of stuff from China, send it dollars, and China invests in American assets. The American trade deficit has since the founding of the nation a couple hundred years ago been key to our success. It means for all our exports, foreigners would rather invest in the U.S. than in almost any other country. We most often have "achieved" temporary trade surpluses only in times of deep recession when investment in the U.S. slows and our imports decline. China, in fact, runs a trade deficit with the rest of the world, a fact telling of China's economic strength, not weakness.
Second, how can we complain about lagging Chinese imports of U.S. goods when we (us, America, the U.S.) prohibit
China from buying some of the most advanced made-in-America products -- namely, high-end semiconductor capital equipment, fast computers, and other high-tech products? China produces more wheat, rice, and even corn than the U.S. At 345 million metric tons, it makes 30 percent of the world's steel
and is a net exporter. It is quickly becoming an automobile colossus
. It is even a key manufacturer of silicon integrated circuits
. Where it has not yet caught up is in some leading edge capital equipment markets, one of our strengths. Our policy (1) discourages China from buying expensive U.S. goods, (2) encourages China to buy from other nations, (3) encourages China to develop an indigenous semiconductor capital capability, and (4) does little or nothing to protect our national security because harming key American technology companies hurts our economy and our technological capabilities key to our military and intelligence services.
Third, bilateral trade statistics really are antiquarian in this seamless, globalized world in which we live. Also, the measurements are imperfect: we are better at counting goods and imports than we are at counting services and exports, and since the U.S. is an 80% services economy, our trade deficit will tend to look higher than it is. But even if our measurements were perfect, the idea that trade should balance is wrong. Economies are not built on equilibria but on creativity and growth -- that is, disequilibria.
Chinese counterfeiting and theft of intellectual property are real concerns, but supposed currency manipulation and trade gaps are self destructive delusions.
John Rutledge, a key economist in the early Reagan administration and since a super smart watcher of financial markets, doesn't like China's currency change. He and I agree that China's U.S. dollar peg has been a boon for both nations over the last decade. (I first wrote about the Chinese monetary issue and urged them to retain the dollar link after visiting China two years ago.) Our mild disagreement now hinges on politics. Were American politicians smarter about economics, and were our own Treasury Department not agitating for a Chinese currency change, I would be perfectly happy for China to continue its dollar peg. The idea that floating and flexible exchange rates are somehow "free market economics" is wrong. The floating currencies themselves are not governed by the market but are managed and manipulated by small groups of fallible humans known as central bankers. In my view, China's move was smart chiefly as a political matter, serving to let the air out of the bulging protectionist balloon without fundamentally changing its "strong and stable" monetary policy. If China's unhinging from the dollar truly leads to the "floating and flexible" monetary relationship U.S. policy makers say they want, along with a substantial revaluation of the yuan, I would join Rutledge in lamenting China's action. My judgment that this is a positive move on net stems from China's brilliant monetary management of the last decade and overall economic strategy of the last 27 years.
A terrific young economist named Mike Darda notes a particular irony in the China money move:
"[P]rotectionists in Congress thought they could jawbone China into dramatically appreciating the Yuan against the dollar to the benefit of U.S. exporters and to the detriment of U.S. consumers and importers. Dropping the dollar peg at a time when the dollar is rallying accomplishes just the opposite."
China today dealt a blow to the protectionist sentiments building in the the U.S. Congress and thus did a great favor to the global economy, especially American technology companies. China slightly changed it currency's (the yuan) value against the U.S. dollar, from 8.3/US$ to 8.1/US$. The move is immaterial economically but allows China to claim it has "revalued." The large revaluation so many U.S. politicians were seeking, but did not get, would have been bad for both China and the U.S.
China has fixed the yuan to the dollar since 1994, a brilliant move by then-economic minister Zhu Rongji. The peg created a single economic fabric stretching across the Pacific, kept China from catching the Asian flu of 1997-98, helped mitigate some of the Federal Reserve's errors, and led to the deep integration of the American and Chinese economies that we both now enjoy. It was exactly the opposite of currency "manipulation" as so many have charged.
China today also said it would drop the dollar peg in favor of a new link to a basket of international currencies. It thus retains the "fixed" nature of its international monetary relationships, a key pillar of China's economic success over the last dozen years, with the added advantage of smoothing away some of the dollar's volatility.
The largest effect is to defuse the Schumer-Graham tariff bomb aimed straight at the heart of the U.S. economy.