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Thursday, May 10, 2007 3:23 PM


Congress Targets China on Currency Manipulation


The LA Times is reporting Congress to press China over its undervalued currency.

Democrats in Congress have been pushing an ambitious trade agenda, promising to assist displaced American workers and reduce the trade deficit. Now they're taking on the global currency market — vowing to pass legislation to punish China and other Asian countries for undervaluing their currencies.

One economist urged Congress to act quickly to level the global economic playing field. "The risk of inaction is much greater than the risk of decisive, progressive action," said C. Fred Bergsten, director of the Peterson Institute for International Economics and a former Treasury Department official.

Bergsten said the yuan needed to rise about 35% against the dollar during the next few years to reduce the annual U.S. current account deficit by about $150 billion.

He noted that the U.S. trade deficit hit $836 billion last year, a historical high, including a $233-billion deficit with China alone.

On Wednesday, Rep. Sander Levin (D-Mich.), who chaired the joint hearing, focused on a proposal by Rep. Duncan Hunter (R-El Cajon) and Rep. Tim Ryan (D-Ohio) favored by manufacturers. The legislation would slap tariffs on countries whose industries benefit from currency manipulation and force the Bush administration to hold China accountable for violating past trade agreements that bar currency manipulation.

It would be a radical move for Congress, which has rarely attempted to legislate changes in currency markets, said Peter Morici, an economist at the University of Maryland.

But Morici said Congress was well equipped to grasp the risks of currency manipulation to the U.S. manufacturing sector and to shape and evaluate legislation. He said it would be akin to writing a complex tax package.

"They don't have to be international economists to vote for this," Morici said.

"This is not something the markets can fix because the markets are being thwarted by other countries," said Thea Lee, the AFL-CIO's policy director in Washington.

"The United States runs trade deficits not because it is victimized by unfair competition from China or anyone else but because it suffers from a chronic shortfall of domestic saving," said Stephen S. Roach, chief economist at Morgan Stanley, calling legislation such as the Ryan-Hunter bill a "policy blunder of monumental proportions."
Apparently it is not manipulation for the US to slash interest rates to 1% and Japan to 0% but it is manipulation to peg to another currency. Can someone tell me why setting interest rates in a soviet command style manner is not manipulation? What about our crop supports? Our massively counterproductive ethanol policy? Is it only manipulation when the other guy does it?

The idea that Congress is well equipped to grasp the risks of currency manipulation is as frightening as it is absurd. Long time Mish readers know where I stand on this: with Roach. The problem is not that the rest of the world consumes too little the problem is the US consumes too much.

Anyone who thinks raising prices on goods from China by 35% will solve our problems belongs in an insane asylum, not Congress. This proposed legislation would have the same effect that the Smoot-Hawley Tariff Act had in exacerbating the great depression. Bush no doubt would veto such legislation, but will the next Democrat president sign such a bill or not?

Protectionism is not the answer. The first country that totally embraces free trade regardless of what any other country does will be a huge winner. But it's not just Congress in La-La-Land, check out the inane comments coming from our treasury department.

Reuters is reporting low Japan yen value stems from deflation.
A senior U.S. Treasury Department official said on Wednesday the low value of Japan's yen was caused by a lengthy bout of deflation from which Japan still is recovering, not from manipulation.

"The yen's real effective value is the result of a protracted bout of deflation in the Japanese economy that coincided with rising prices in the United States and other trading partners of Japan," Deputy Assistant Treasury Secretary Mark Sobel said in prepared remarks for delivery at a hearing in the U.S. House of representatives.

He said Japanese officials have not intervened in currency markets to affect the yen's value since March 2004 and said it was important for the rest of the world that Japan have time to regain more economic vigor.

"One of the most important contributions Japan could make to the global economy, and to U.S. firms and workers, would be to resume sustainable and robust domestic demand growth and exit completely from deflation," Sobel said.

Sobel, who plays a key role in assembling Treasury's semi-annual reports on currency practices of key trade partners, repeated that China was not moving rapidly enough toward a flexible currency that would let its value rise in response to its growing economic might.

He said Treasury Secretary Henry Paulson, who will play host to a delegation of top-level Chinese officials in a second round of "strategic economic dialogue" talks on May 22-24, will drive home the point that the rest of the world wants action.

"Secretary Paulson has told his Chinese counterparts repeatedly that the greater risk is in China moving too slowly," Sobel said, "The secretary will again emphasize this message during the upcoming meeting of the strategic economic dialogue."
Since Sobel has no beef with Japan, one also must conclude that we want a weak Yen (to prolong the carry trade), but a strong Renmimbi on the misguided assumption that somehow it will save US manufacturers. It won't. And Paulson is going to drive home the point that the rest of the world wants action. Haven't we been driving home that point for years?

I am not the only one shaking my head over these comments by Sobel and Paulson. Let's review some key points made about the Yen by Professor's Scott Reamer and Kevin Depew in today's "Five Things".
  • A senior U.S. Treasury Department official, in prepared remarks at a U.S. House of Representatives hearing yesterday, said that the low value of the Japanese yen was caused by a lengthy bout of deflation and not from manipulation.
  • Wait, let's think about this for a moment.
  • That would mean that, at least according to the U.S. Treasury's understanding of deflation, the declining value of the yen was caused by the fact its purchasing power was increasing. What? Really?
  • Look, there may be some irrational aspects to global macro finance, but one thing is for sure: deflation does not cause a country's currency to decline... not without intervention.
  • Minyanville Professor Scott Reamer and I were discussing this very thing this morning.
  • He put it very succinctly: "Look, the three weakest currencies in the world are the U.S. dollar, the yen, and the yuan. (1) We print too much and the USD is a global reserve, currency, and (2) China and Japan both intervene massively to keep their currencies artificially low. Those policies together have combined to create the credit led hyperinflation of assets we have seen."
  • It's actually easy to understand when seen that way.
  • Those policies, and the market's embracing of them (via the yen carry trade, among other things) is what leads to asset hyperinflation (homes, stocks, CDOs, etc).
  • If those policies end because officials don't want them anymore (BOJ, PBOC changing policy, for example, or due to protectionist issues), or if market participants carry those policies too far, then you get instability and a reversal of those policies regardless of what the governments want.
  • "And that's when you get the opposite of what drove the speculation in the first place - the end game," Scott notes. "A deflationary credit contraction."
The end game has long been set in stone. The only things in question are how silly things get with leveraged buyouts and debt funded stock buybacks in the meantime, and whether or not Congress passes another Smoot-Hawley type bill in response.

This post originally appeared in Minyanville.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

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