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 Richmans' Trade and Taxes Blog

Revaluing the Yuan Will Not Balance Our Trade with China; Tariffs Will.
Raymond Richman, 3/17/2010

Nobel Prize-winning economist Prof. Paul Krugman, in a series of recent op-eds, has decried China’s policy of keeping its currency, the renminbi or yuan, undervalued to maintain and grow its chronic trade surpluses with the U.S. and other nations. An increase in the value of the rrenminbi relative to the dollar would make Chinese goods more expensive to Americans and U.S. goods less expensive to the Chinese which economists believe would stimulate demand for U.S. made goods and reduce demand for Chinese made goods. The trouble with this view is that the Chinese government denies consumers the foreign exchange required to import U.S. goods and services. In 2008, our trade deficit with China reached $268 billion, representing a loss of about 2.7 million US industrial jobs over the course of the last two decades. In 1989, our trade deficit with China amounted to $6.2 billion, or about 1/40th of the 2008 deficit.  In 2008, our trade deficit with the rest of the world totaled over $800 billion, roughly equal to Pres. Obama’s economic stimulus plan to exit the recession. Balancing the trade deficit at the 2008 level of imports would create 8 million U.S. jobs.

In his most recent op-ed which appeared on the internet, March 14,  Prof. Krugman called for a 25% percent increase in the value of the yuan relative to the US dollar, implying that such a revaluation of the renminbi would bring our trade with China into reasonable balance. A hundred and thirty US legislators of both parties have called for the U.S. to put pressure on China to revalue her currency. We do not believe that fluctuating exchange rates would be successful in reducing the trade imbalance. We believe there are many ways for mercantilist nations to restrict imports and subsidize exports in spite of a revaluation of currencies.

We had a forty percent fall in the value of the dollar relative to the euro during the past decade without bringing our trade with Germany into balance.  Germany had a $28 billion trade surplus in its bilateral trade with the U.S. in 1999 and it grew to $43 billion in 2008 notwithstanding the fall in the value of the dollar relative to the euro. Similarly, Japan in 1999 had a trade surplus with us of $56.1 billion and it grew to $74.1 billion in 2008.

In 1971 the United States under Pres. Nixon imposed a 10 percent surcharge on imports, which was removed when Germany, Japan and other nations raised the dollar value of their currencies. We believe that China would respond as Germany and Japan did following the U.S. action in 1971. They appeared to be addressing U.S. concerns while taking actions to avoid the effectss of a revaluation of currencies. In any case, it had little long-term effect. We continued to have large deficits with Germany and Japan although admittedly not as large as those we have been having with China. To force China to agree to a revaluation, Krugman calls for a 25% temporary surcharge on all imports from China. As he writes, “Without a credible threat, we're not going to get anywhere." We agree but not as a measure to force China to revalue its currency.

The rules of the World Trade Organization permit countries experiencing trade deficits to impose barriers on imports such as tariffs and quotas. We have never exercised our right to do so, in spite of the loss of millions of American jobs and the closing of thousands of American factories, which had the effect of de-industrializing America. In our book, Trading Away Our Future (Ideal Taxes Assn, 2008), we proposed a version of Warren Buffett’s suggestion creating import certificates which would limit imports to the amount of our exports. But it would require the establishment of a new federal bureaucracy to manage the distribution of the certificates. It would invite corruption and favoritism. A simpler and less costly (indeed profitable) way to limit imports would be to impose a uniform tariff on all imports from countries with which we are experiencing chronic deficits. The rate would rise or fall with changes in the trade imbalance. Tariffs work like a revaluation of currencies in that it makes foreign goods more expensive to Americans. They also yield tax revenues, not an unimportant gain!

It is true that a revaluation of currencies would make our goods more attractive to foreigners but it would not bring trade into balance. Its effects can be too easily avoided without detection. Countries have an infinite number of ways of imposing barriers to imports and subsidizing exports that are not transparent. Just controlling the availability of foreign exchange would be sufficient to limit imports. There are many forces at work at home and abroad that affect the amount of a country’s imports and exports. China’s trade surplus is not the result of the low value of its currency but the result of specific barriers to trade including the fact that it does not make importing easy and by the fact that its businesses and private citizens have little access to foreign exchange. 

We recommend imposing a tariff at a common rate on all imports from each country with which we are experiencing a large chronic trade deficits. The tariff that would last as long as necessary to bring trade into balance, be increased if it proves to be insufficient to bring trade into reasonable balance, or be decreased when, as, and if trade is brought into reasonable balance.

If China reacts positively, it will revalue her currency of its own volition sufficient to bring trade into balance at a high level of trade. The politics of the tariff versus trying to force China to revalue her currency would be much more salutary. China would understand our action since it has been imposing trade barriers from the beginning. Pres. Obama’s and U.S. lawmakers’ suggestions that China revalue its currency appeared to Chinese officials to be interference in its domestic policies. A tariff imposed in accordance with WTO rules would not constitute foreign interference.

As reported in the WSJ on March 13, China responded sharply to Pres. Obama’s suggestion that it revalue the yuan and change its human-rights practices. That is direct pressure to get China to change her trade policies. A senior Chinese bank official accused the U.S. of politicizing the exchange-rate issue. He also said revaluing currencies does not necessarily resolve trade imbalances. As indicated above that is also our position. The imposition of a tariff in accordance with WTO rules does not create a clash of wills.

The world crisis, in the words of China’s report, was caused “by the U.S. subprime crisis-induced global financial crisis…”  We agree with that but that has little to do with the enormous trade surpluses China has with the U.S. That is the result of China’s two growth strategies, import-substitution barriers to US goods and an export-based strategy to grow at the expense of existing U.S. industries, both strategies implemented by mercantilist policies. 

The U.S. is not attractive to many foreign and domestic corporations as a place to build factories and produce goods. In our book, we suggested abolition of the corporate income tax, converting the personal income tax into a progressive consumption tax by simply exempting income saved from income taxation, removal of government barriers to drilling for oil and gas on public lands and offshore. They will in conjunction with a reasonable trade balance increase investment in producing goods for domestic consumption and for export. This will   substantially increase industrial employment with its attendant multiplier effects, unlike Pres. Obama’s economic stimulus program whose stimulus ends as soon as the government spending ends as was observed in the 1930s. Not until new industrial products were produced in response to the outbreak of WWII did the U.S. recovery become self-sustaining.

Our presidents have long had the power to impose and change tariffs without seeking congressional approval. It is time that one of them acted to bring trade into balance.