Senators Blindly Promising to "Get Tough" on China's Currency

The US Senate is poised to take up the issue of China's currency policies, and nothing - certainly not some measly little facts that totally undermine the issue's relevance - is going to slow the legislation down.  You see, in today's Senate - one that hasn't passed a budget in almost 900 days - politics trumps reality.  Every single time.

Last Thursday, a bi-partisan group of Senators, led by Sens. Chuck Schumer (D-NY) and Sherrod Brown (D-OH) announced their much-anticipated legislation targeting China's currency policies:

Senators Charles Schumer of New York and Sherrod Brown of Ohio, both Democrats, urged support for legislation pushing China to raise the value of its currency as a way to stem U.S. job losses.

China’s currency policies cost more than 2.8 million U.S. jobs since 2001, the lawmakers said today at a Washington news conference. The legislation would let U.S. companies seek duties on imports from China to compensate for the effect of a weak yuan, which lawmakers said gives Chinese companies an unfair advantage against U.S. manufacturers.

“They get away with economic murder,” Schumer told reporters. “We are fed up; we are not going to take it anymore.” 

Schumer proposed similar measures in each of the past six years. None has received a Senate vote. The bill also is supported by Democratic Senators Robert Casey of Pennsylvania and Debbie Stabenow of Michigan, and Republicans Lindsey Graham of South Carolina, Richard Burr of North Carolina and Jeff Sessions of Alabama.

So to recap the Senators' argument: China's undervalued currency has eliminated 2.8 million US jobs, and these brave Senators want to empower US companies to seek new tariffs on Chinese imports in order to force China's hand.  Sounds almost plausible, but there's one big problem: every single "fact" in that previous sentence is dubious.

At best.

First, the employment study that the Senators cited - by the union-run and union-funded Economic Policy Institute - is total economic bunk.  I've already been over this fact several times, citing to myriad economists who have explained that EPI's methodology, which simply ties the US trade deficit to American job losses, is utter poppycock.  Cato's Dan Ikenson elaborated on this little fact last week, showing how EPI's so-called "findings" fly in the face of both economic theory and reality:

As the chart below (which is based on easily verifiable figures published in the Economic Report of the President) reveals, the trade deficit and job creation appear to be positively correlated. When the deficit rises, employment increases; when the deficit shrinks, employment declines. So, right off the bat, a central premise of [EPI's Robert] Scott’s analysis is in doubt.... 

Last month, the U.S. International Trade Commission published its seventh update to the “The Economic Effects of Significant U.S. Import Restraints” study, which contains a special section on global supply chains. On page xv of the executive summary is a table that not only raises more serious doubts about EPI’s methodology, but should put to rest once and for all the hyperbole employed and anxiety caused by alarmist public relations campaigns and the politicians they serve.

Table ES.4 of that study indicates that there is more U.S. valued added (U.S. labor, material, and overhead) in U.S. imports than there is Chinese valued added in U.S. imports. Specifically, 8.3 percent of the value of U.S. imports (about $160 billion last year) is U.S. value, while 7.7 percent of the value of U.S. imports is Chinese value added. EPI’s methodology does not account for the U.S. jobs associated with the U.S. value added in U.S. imports.

Furthermore, that same table reveals that U.S. value added accounts for 89 percent of total U.S. consumption (a figure that confirms the findings in a recent San Francisco Federal Reserve study), which means that foreign value-added accounts for just 11 percent of U.S. consumption, making the United States a fairly closed economy—or at least, a relatively non-integrated economy. And China? Well, China only accounts for a measly 0.9 percent of the goods and services consumed in the United States. So, if 2.8 million U.S. jobs were lost to a country that produces less than one percent of what Americans consume, I say its about time we shed those highly inefficient jobs that have been a drag on the U.S. economy. The fact is, however, that 2.8 million is a fiction....

Yes, the 2.8 million job loss figure is a fiction, concocted to support political talking points and a narrow agenda that distract the public from the real problems that ail our economy. Some Chinese government policies are genuine causes for concern, worthy of efforts to resolve, but we limit our capacity to address the real problems effectively when every last gripe becomes a call to arms.

In short, the EPI study is totally worthless for anything other than shameless political demagoguery.  Fortunately for EPI, that just happens to be a certain New York Senator's specialty!  Unfortunately for the rest of us, most reporters hired to cover that Senator's currency shenanigans don't do their homework and instead treat the "study" cited by Schumer (and others) as gospel.

Shame on them.

The second problem with the Senator's argument is that most US companies aren't begging for relief from China's currency policies.  Indeed, a lot of them are literally begging the Senate to back off the currency issue and focus on other, real bilateral trade issues.  For example, just last week over 50 trade associations, representing hundreds (if not more) US companies, sent a letter to Senate leaders asking them to drop the tough currency talk.  The full letter is available online and definitely worth reading, but here are some key excerpts:

We agree with many in Congress and the Administration that China needs a yuan exchange rate that responds to trade flows and that China should move steadily towards a market-determined exchange rate.

However, unilateral legislation on this issue would be counterproductive not only to the goals related to China’s exchange rate that we all share, but also to our nation’s broader objectives of addressing the many and growing challenges that we face in China.

Legislation that would increase tariffs on imports from China is unlikely to create any incentive for China to move expeditiously to modify its exchange policies. Rather, it would likely have the opposite effect and result in retaliation against U.S. exports into China – currently the fastest-growing market for U.S. exports.

We urge you to oppose currency legislation and instead work with and vigorously call on the Administration to develop a robust bilateral and multilateral approach to achieve tangible results, not only on China’s exchange-rate policies, but also on other Chinese policies that are harming American economic interests.

The business group letter also highlights the third problem with Schumer's plan: unilateral US action (i.e., tariffs) against China are unlikely to convince the Chinese government to do anything except resist further Yuan appreciation and retaliate against US exports and companies.  As I said earlier this month about Mitt Romney's misguided plan to aggressively target China's currency via Executive Order:

The idea that the Chinese government would just roll over and concede "defeat" in the face of President Trump[Romney]'s big, macho tariff is absurd.  First, Trump[Romney] fails to grasp that the Chinese government would never, ever do anything that makes it appear weak in the face of American aggression.  Instead, retaliation, not concession, is the far more likely reaction (just as China did when President Obama imposed those tire tariffs), and such sinophobic chest-thumping would likely retard, not quicken, the gradual appreciation of the yuan that China needs to undertake.  Second, China's not nearly as dependent on the US market as Trump[Romney] seems to think.  The EU is now China's biggest export market, and Chinese exports to the US represent under 30% of China's exports to its top 10 export destinations.  So while the US market is big and important, China has other options.  Third, China couldn't rapidly and dramatically appreciate its currency even if it wanted to because any such move would implode the Chinese - and by extension, global - economy.

So the tariffs probably won't change China's behavior, and they definitely will harm US companies and consumers.  Thanks for nothing, Senators.

Finally, it's far from clear that the Yuan remains significantly undervalued against the US dollar.  I've already discussed this inconvenient truth repeatedly, and news last Friday about a massive selloff of Yuan further undermines the conventional wisdom regarding China's currency:

A rush for safe investment havens led to an unexpected drop in the value of the Chinese yuan traded outside the mainland, as global investors eschewed a bet on a currency widely seen as undervalued for the comfort of the U.S. dollar and the Japanese yen. The move will have little effect on yuan as a whole because Beijing still tightly controls the currency. But it offers an example of the uncertainties China could face as it moves in fits and starts to loosen its restrictions on the yuan and give it a more central global role.

The drop took place mostly in Hong Kong, a Chinese city that operates under its own set of laws and the only place where the yuan can be traded outside the Chinese mainland. Chinese officials over the past year have transformed the city into a laboratory for yuan liberalization, allowing everything from the issuance of yuan-denominated bonds to yuan-trade settlement to yuan accounts for individual investors.

Until this week, the Hong Kong-traded yuan had remained broadly in line with the official yuan trading range. But market turmoil Thursday and Friday prompted the Hong Kong price to slump at one point to a discount of as much as 2.5% to the mainland yuan, the biggest gap since China began relaxing its currency restrictions about a year ago. The yuan on the mainland trades in a tight band because of Beijing's restrictions on its currency.

The discrepancy between Hong Kong-traded yuan and mainland yuan, known as of offshore market and the onshore market, respectively, later narrowed somewhat but remained high by historical standards, and late Friday traded at 6.49 yuan to the dollar in Hong Kong, compared with 6.39 yuan in the mainland. The moves fly in the face of currency-market conventional wisdom, which holds that the yuan is set to rise against the U.S. dollar as China soaks up capital and trade flows.

The selling pressure overwhelmed a facility set up by China to sell yuan at the mainland rate, which on Friday was offering investors more dollars for their yuan. Late in the day, Bank of China Ltd.'s Hong Kong arm, the designated clearing bank for the Hong Kong market, said it would temporarily stop buying yuan used for trade settlement as its quarterly quota for such transactions was full....

Market turmoil also roiled the market for yuan nondeliverable forwards, which are offshore derivatives that track the value of the yuan but can't be exchanged for the currency. The dollar one-year forward on Friday was bid as high as 6.47 yuan against the domestic spot rate of 6.39 yuan, implying expectations of a 1.3% yuan fall over the coming months.

Until now, global investors have largely adopted a strategy of shorting the dollar for the yuan on expectations that Beijing would continue to allow its currency to rise. In fact, desire for yuan offshore has caused the Chinese currency traded in Hong Kong to boast a premium over its mainland counterpart at most times.

Now, worries of an economic recession around the globe and a Greek debt default are driving investors back into the relatively safety of the U.S. dollar, leading many investors to sell yuan and other currencies for dollars.

For those of you (like me) who aren't currency experts, investors don't typically flee an "undervalued" Yuan for an "overvalued" Dollar.

So to summarize: the Senators are using a debunked economic study to justify their targeting a problem that might not even exist with a strategy that will never work on behalf of a constituency that doesn't want their help.

But other than that....

New "Big Mac Index" Pokes Yet Another Hole in China Currency Hawks' Boat

One of the more mainstream, if admittedly crude, measures of the relative value of countries' currencies is The Economist's "Big Mac Index."  As the magazine explains, the index "is based on the theory of purchasing-power parity (PPP), the notion that in the long run exchange rates should move towards the rate that would equalise the prices of an identical basket of goods and services (in this case, a burger) in any two countries."  For years now, people seeking aggressive unilateral action by the US government to "force" China to appreciate its currency have cited to the Big Mac Index as further proof that the Yuan is, like, totally undervalued and hurting the American economy (insert ominous music here).

For example, the AFL-CIO's "China Currency Coalition" cited to the Index in its 2004 petition to the US Trade Representative under Section 301 of US Trade Law, demanding that the United States impose "across-the-board tariffs on imports from China and to take measures to offset the disadvantage to U.S. exports to China."  More recently, the Fair Currency Coalition, an alliance of businesses, farmers and unions seeking similar actions by the US Government, approvingly cited to the Big Mac Index in a 2010 blog post, and several angry journalists have also relied on the index in order to complain about China's allegedly pernicious behavior (and, of course, politicians' refusal to "get tough" against the dirty commies Chinese).

The House Ways and Means Committee also has used the Big Mac Index to support its interventionist trade policies.  In September 2010 the Committee, Chaired at that time by Rep. Sander Levin (D-MI), issued a briefing memo to journalists showing that the Yuan was undervalued (based, in part, on the index) and that this alleged undervaluation is harming the American economy.  As you may recall, that memo was issued right before House Democrats spearheaded the unprecedented congressional passage of (anti)China currency legislation.  Even reputable economic journalists like the New York Times' Catherine Rampell have discussed the Big Mac Index as a respectable measure of the Yuan's significant undervaluation.

So, clearly, all of these folks think that the Big Mac Index is a worthwhile measure of countries' respective currencies, and thus I'm expecting them to be all over this new report from the folks at The Economist about the new and improved Index (emphasis mine):

At market exchange rates, a burger is 44% cheaper in China than in America. In other words, the raw Big Mac index suggests that the yuan is 44% undervalued against the dollar. But we have long warned that cheap burgers in China do not prove that the yuan is massively undervalued. Average prices should be lower in poor countries than in rich ones because labour costs are lower. The chart above shows a strong positive relationship between the dollar price of a Big Mac and GDP per person.

PPP signals where exchange rates should move in the long run. To estimate the current fair value of a currency we use the “line of best fit” between Big Mac prices and GDP per person. The difference between the price predicted for each country, given its average income, and its actual price offers a better guide to currency under- and overvaluation than the “raw” index. The beefed-up index suggests that the Brazilian real is the most overvalued currency in the world; the euro is also significantly overvalued. But the yuan now appears to be close to its fair value against the dollar—something for American politicians to chew over.

Be sure to check out the great charts at their site.  Very interesting stuff.  If you're still a little confused about how things changed so much, the Wall Street Journal provides some helpful detail and commentary (again, emphasis mine):

The index is based on the theory of purchasing power parity (PPP), essentially the idea that goods should cost the same in markets around the world no matter what currency they are priced in. Since Big Macs sell for 44% less in China than the U.S., the yuan is therefore figured to be 44% undervalued against the dollar.

But PPP only applies to tradable goods that are easily exchanged across borders, like commodities or electronics. Other, less mobile goods like labor and land may well cost different amounts in different markets, and in particular in developing countries where productivity and wages are much lower. Since labor and land are important inputs into the production of Big Macs, these differential costs feed through into the final cost of the burger.

Hence the new Big Mac index, which adjusts for GDP per capita, and thus takes into account the lower costs in poorer countries. As the magazine notes, China’s average income is one-tenth what it is in the U.S., meaning China’s burgers really ought to be substantially cheaper.

New York Senator and prominent yuan critic Chuck Schumer might want to make sure he’s sitting down before he checks out the Economist’s results, which show that on this basis the yuan is actually overvalued against the dollar by 3%. Against a group of various currencies, the yuan is still figured to be undervalued by 7%. which the Economist says is “hardly grounds for a trade war.”

Yes, based on this news, I totally expect Senator Schumer, Rep. Levin, the currency coalitions, and every other currency hawk who has ever approvingly cited to the Big Mac Index to loudly and immediately retract their earlier statements/reports criticizing China's currency policy, or to just drop their breathless protectionist demands altogether.

Riiiiight.


In all seriousness, the point here is not to boldly assert that the new Big Mac Index undoubtedly proves that the Yuan is no longer undervalued.  It's instead to caution, once again, against trusting anyone - whether it be a campaigning politician or a labor union lawyer or a lazy journalist - who aggressively seeks dangerous protectionism based on unequivocal claims that China's currency is significantly undervalued, and that such undervaluation is destroying the US economy.  The facts simply prevent such certitude, and often reveal currency hawks' ulterior motives.

Something to remember now that the 2012 election season is almost upon us.

Commerce Dept. Refuses to Investigate Chinese Currency Policies: Good News, Bad News

Today's big trade news is that the U.S. Department of Commerce has formally refused to initiate an investigation of whether China's currency policies provide illegal (i.e., "countervailable") subsidies to Chinese exporters of aluminum and (in a separate case) coated paper.  Although this decision was pretty much expected after last week's, err, rather timely announcement that DOC was implementing a myriad of new policies that would tend to increase duties against China and other "non-market economies," today's currency announcement is still a good and welcome development.

But let's not pop the champagne corks just yet, ok?

Now, before we get to all that, let's start with a little background on the cases, courtesy of Reuters (lots more here, if you're interested):

The U.S. Commerce Department, in a decision that could provoke congressional action, said on Tuesday it did not see strong enough legal grounds to investigate if China's currency practices subsidize its exports.

It made the decision in separate trade cases involving imports of coated paper and aluminum "extrusions" from China.

In both cases, U.S. petitioners argued China effectively subsidized exports by keeping its currency at an artificially low value to the dollar and asked the department to impose countervailing duties in response....

Many U.S. manufacturers and lawmakers believe China's currency is undervalued by as much as 40 percent, which they say gives Chinese companies an unfair trade advantage....

The United Steelworkers union and aluminum extrusion producers in nine states asked the Commerce Department in April to impose countervailing duties over China's yuan as part of a broader case alleging a long list of government subsidies and unfair pricing practices.

Since then, agency officials had been mulling whether they had strong legal grounds to launch a formal investigation into the charge China effectively subsidizes its exports by keeping its currency undervalued against the dollar.

Under both U.S. and WTO law, a subsidy is defined as a financial contribution from the government which provides a benefit to a specific industry.

In the aluminum case and a separate one involving coated paper, U.S. petitioners have argued the benefits that come from the Chinese government controlling its currency are specific to Chinese exporters since they account for about 70 percent of the country's foreign exchange transactions.

And here's the key part of DOC's announcement:

[T]he Department of Commerce announced that two allegations before it that China’s currency practices constitute an unfair subsidy under U.S. countervailing duty law failed to meet the requirements for the initiation of an investigation. The currency allegations under review were made in the context of both the aluminum extrusions case as well as a CVD investigation of coated paper from China.

“Today’s currency decision was based on a careful evaluation of the specific legal arguments and evidence put before the department, in relation to the standards for the initiation of an investigation under the CVD law,” Deputy Assistant Secretary for Import Administration Ronald K. Lorentzen said. “In these two cases, the Department has determined not to investigate whether the alleged undervaluation of China’s currency, the RMB or yuan, is a countervailable subsidy, because the allegations made by domestic producers do not meet the statutory standard for initiating an investigation under the requirement that benefits provided under China’s unified foreign exchange regime be specific to the enterprise or industries being investigated.”

The DOC source documents are available here, here and here.  I'll try to avoid getting into the weeds too much here, but the agency rejected the petitioners' subsidy allegation because they failed to prove that the China's currency policy was either a prohibited export subsidy or a domestic subsidy that was specific to a particular company, industry or group of companies or industries.  On the latter point, DOC importantly found that:

China’s currency regime is broadly available across the Chinese economy to all firms that exchange foreign currency and thus does not single out any enterprise, industry or group thereof. Indeed, the exchange system of China is “unified,” meaning that there is only one “price” for every user. Given that all enterprises and individuals in China that convert allegedly overvalued foreign currencies into RMB are recipients of the alleged subsidy, and in light of the findings in previous cases noted above, Petitioners have not sufficiently supported their claim that the undervaluation of the RMB is specific to any enterprise, industry, or group thereof.

This, of course, makes a lot of sense and follows WTO rules, but you never know what zany legal argument might just work in these investigations, so it's still good to read in the Federal Register.  Also interestingly, DOC punts on whether petitioners proved that a "financial contribution" exists - another major point of contention - but I guess we'll have to leave that issue for another time.

Finally, and as if to eliminate any doubt that last week's industry/union-friendly decision to "tweak" several policies with respect to US trade remedies law and non-market economies was a down payment on today's news, the very next paragraph of the press release provides the "hey-unions-don't-get-too-mad-remember-last-week" conclusion:

In addition to today’s decisions, Commerce last week announced a package of 14 measures – especially focused on unfair import practices by non-market economies – that will strengthen trade enforcement and help keep U.S companies competitive. These steps support President Obama’s National Export Initiative (NEI), which aims to double exports in the next five years and support the creation of several million new jobs. The proposed changes came in response to U.S. Commerce Secretary Gary Locke’s call to survey the agency’s current trade remedy practices in order to determine how the department could improve the effectiveness of its existing enforcement tools.

That's about as subtle as Lady Gaga, I'd say.

Now let's hit the (pretty obvious) good news.  DOC's announcement is a victory for--

• American families and import-consuming companies.  Treating china's currency policy as a countervailable subsidy basically would have made every Chinese import "illegally subsidized" by the amount that RMB is found to be undervalued by DOC (maybe 40% or higher).  This would allow domestic producers and/or their unions to petition the government for the imposition of an essentially "automatic" 40% duty on any Chinese product and, if the US government agreed after a CVD investigation, that product - anything from Chinese steel and solar panels to food and clothing - would become that much more expensive in the US market.  Ouch.  Moreover, the mere threat of increased CVD cases against Chinese products - something this would almost certainly bring about - would likely have a chilling effect on Chinese exporters, as they pull back from the US market in order to shield themselves from future litigation and (maybe) duties.  Double ouch.

• American exporters.  Of course, no one would expect the Chinese government to take a change this important lying down.  And, if last year's Section 421 investigation against Chinese tires is any indication, the first group hit would be US exporters.  Now, I was always skeptical about export-led economic growth in the US, but this certainly wouldn't help matters.

• Free traders and US trade policy in general.  In the face of sagging poll numbers and intense pressure from some domestic corporations and labor unions, the Obama administration has (for the moment, at least) decided not to open an enormous can of worms and begin attacking China's currency policies through the blunt and easily-manipulated tool of the US countervailing duty (CVD) law.  Good for them.

Unfortunately, today's news is not all wine and roses, as there are still several reasons to be irked about the admininstration's latest moves.  First and foremost, there's still a long way to go in the Great China Currency Debate of 2010.  DOC's decision can be appealed, or the agency could change its mind at a later date (the standard for such a change is very low).  But more importantly, Congress - and its many China-bashing members - still gets a say on the issue, as the aforementioned Reuters article makes clear:

Senator Charles Schumer, a New York Democrat, who has been pushing for action on China's currency in the Senate, criticized the Commerce Department's "incomplete" decision.

"Once again, even when the opportunity is thrust into its hands, the administration has refused to take action," Schumer said.

The House of Representative Ways and Means Committee will hold a hearing Sept. 15 on the concern and is expected to hear testimony from lawmakers and groups supporting legislation to address the situation.

Schumer's up for re-election this November, so we all know that the big guy's gonna have a field day with DOC's news and demagogue the issue until election day (at least).  And with Ways and Means Chair Sander Levin (D-MI) venting about today's DOC decision, as well as the RMB's lack of movement over the summer, this controversial issue is far from settled on Capitol Hill.  Oh, and let's please not forget that the Treasury Department's semi-annual negotiating toolreport on foreign currency practices is due again in mid-October, so even the administration has another bite at the protectionist apple this year.

Second, today's decision is also not a sign that President Obama has suddenly become a staunch free trader because the move (apparently) came at a price - those 14 new "non-market economy" policies announced last week.  A real free trader wouldn't have needed to make such a "bargain," but I'm not even sure that a this was a best-that-can-be-expected outcome.  Considering that the currency-CVD issue is fraught with legal, political and foreign policy peril, one must question whether those 14 new policies - which will very likely lead to more and higher duties on Chinese imports and almost certainly won't appease anti-traders - were really a fair price to pay for DOC's currency decision.  As I mentioned above, the cost of an affirmative DOC decision was going to be pretty darn high in terms of corporate and foreign backlash and would have led to a litany of litigation in US courts and at the WTO.  (I've already pointed out how strong some of the WTO arguments against currency/CVD action are, and the Chief Judge of the US Court of International Trade - which would handle any appeal of DOC's decision - has just recently reiterated her immense displeasure with DOC's handling of the whole "China CVD" issue.  Furthermore, just carrying out the new policy might have been an unworkable nightmare for the agency.)  And Congress might still take the bull by the horns and force the issue this fall.

Thus, DOC's "big compromise" was really a decision to trade (i) a very public and very political battle over an dog of a legal issue that could've started a major trade conflict with China and might still be handled by a protectionist Congress for (ii) a myriad of less-publicized-but-still-pretty-effective anti-China measures.  Meanwhile, the administration can appear to be even-handed and even kinda pro-trade - something that might help a little with that pesky anti-business label that the President can't seem to shake.  In that light, the tradeoff's not nearly as cut-and-dry as it would first appear.

Now, I don't mean to imply that today's currency decision isn't a bigger deal than last week's "non-market economy" policy announcement.  It certainly is bigger, and it's heartening to see DOC do the right thing here, even if it took some, ahem, "tough choices" to make that happen.

But let's not tear a rotator cuff patting the administration on the back, ok?

It's Baaaaaack....

After a glorious two-month oasis of silence on China currency, the issue is back with a vengeance.  (I swear, this thing is harder to kill than the Terminator.)  Yesterday, everybody's favorite China-demagogue Sen. Chuck Schumer (D-Campaigning) announced to the US-China Economic and Security Review Commission that he and his Senate colleagues would advance legislation unilaterally attacking Chinese imports unless China appreciates its currency (the RMB) by the end of the June 26-27 G-20 Summit in Toronto.  Reuters details the comments here:

U.S. congressional anger over China's currency and trade practices boiled over on Wednesday as senators vowed to pass legislation soon and lashed out at President Barack Obama's administration for failing to get tough with Beijing.

"Years of meetings and discussions with Chinese officials in an effort to persuade China to float its currency have repeatedly failed to produce lasting and meaningful results," Senator Charles Schumer told the U.S.-China Economic and Security Review Commission, a watchdog group appointed by Congress.

"No question, this is what is called a 'put up or shut up' moment for lawmakers," the New York Democrat said.

Schumer told the commission that he and other colleagues would push for a vote "in the next two weeks" on legislation that would allow the Commerce Department to use anti-dumping and countervailing duty laws against China or any other country with a fundamentally misaligned exchange rate.

He blamed China's undervalued currency for millions of lost U.S. manufacturing jobs and thousands of closed facilities.

Getting Beijing to allow its currency to rise to a more market-oriented exchange rate would do more to create jobs in the United States than any new stimulus package, Schumer said....

Schumer and [fellow protectionist Sen. Lindsay] Graham are expected to offer their bill as an amendment to a broader piece of legislation, rather than try to pass it on its own.

For the bill to be enacted, it would also have to be approved by the House of Representatives and signed into law by Obama.

Schumer and many of his Senate colleagues - from both political parties - echoed such angry sentiments at today's Senate Finance committee hearing with Treasury Secretary Tim Geithner.  (More on that here, along with some fantastic commentary from some trade lawyer wearing way too much makeup.)  Oh, goody.

Now, I've already laid out in excruciating detail how silly and wrongheaded all of this hyper-political pabulum is from an economic, historical, legal and practical perspective, and the Senators' rhetoric remains par for the course.  Heck, I even predicted last month that those precious weeks of silence on the China currency "debate" would end right about now as these pols resumed their China attacks in preparation for the November midterm elections.  However, a few things have changed since the last time China currency was in the news (i.e., March-April of this year) which make this week's silly rhetorical flurries a little more noteworthy.

First, Greece imploded and took the Euro with it.  Back in April, pretty much everyone "in-the-know" (or at least who unwisely thinks he's i-t-k - like me) was expecting China to allow a one-off RMB appreciation of about 5% sometime right before the G-20 Summit.  Indeed, the DC tea leaves were saying that the G-20 "deadline" was the main reason that the Treasury Department delayed its semi-annual currency report.  But then the Euro collapsed and made everything a lot more complicated.  The EU, afterall, is China's top trading partner, and China is the EU's #2.  So with the Euro falling to levels not seen in years, and with the global currency markets ridiculously unstable right now because of it, the Chinese government is probably going to hold off on any RMB movement until things settle down a bit.  And you really can't blame them.

Second, China announced yesterday that its exports in May surged 48.5% year-on-year, and its trade surplus returned to pre-recession levels (a rather large $20 billion/month).  Imports into China rose by 48.3% too, but let's face it: nobody really cares about that because May's surplus statistics are definitely going to stall (or thwart entirely) any of those budding conclusions that China's tiny April surplus and March deficit signaled that the Chinese economy was finally becoming more consumption-oriented.  Now, given the EU mess, nobody really knows what's going on with China or anywhere else for that matter, but there's no doubt that China's May trade data are going to fuel the congressional currency hawks' fire.  As Patrick Chovanec eloquently put it: "by knocking the legs out from under Chinese arguments that a structural adjustment is taking place without Renminbi appreciation, China’s May export surge is likely to feed into growing US impatience over China’s hesitation in moving on the exchange rate."  Indeed.

Third, the US announced today that is April trade deficit increased 0.6% to $40.29 billion from a revised $40.05 billion in March.  From a purely economic perspective, these new data are pretty bad news: both exports and (non-oil) imports fell - a sign that US economic recovery just isn't ramping up.  But the stats are also unwelcome from a political perspective two reasons: (i) the currency hawks can scream "DEFICIT!" and most people (including a lot of bad journalists) aren't going to know that the US trade deficit's growth was driven entirely by higher energy prices; and (ii) the US trade deficit with China - which is an economically worthless, yet politically effective number - expanded significantly to $19.31 billion in April from $16.90 billion in March.  Yet another thing to point and scream about.

The combination of these three developments, a struggling US economy, and the November midterm elections is definitely going to push China's currency back to the forefront of the 2010 international trade stage and maybe, just maybe, create the perfect political storm to blow some piece of nasty currency legislation across the House or Senate finish line.  Now, I still don't expect any such legislation to ever pass both chambers and make it all the way to President Obama's desk, but I do think that we all should gird our loins for one hot, sticky (and terribly annoying) "Summer of Schumer."

Ugh.

White House Votes Present on China Currency; Smart Move?

Bloomberg reports that Treasury Secretary Tim Geithner has decided to delay the April 15 Treasury report on foreign currency practices:

U.S. Treasury Secretary Timothy F. Geithner delayed a scheduled April 15 report to Congress on exchange-rate policies, sidestepping a decision on whether to accuse China of manipulating the value of the yuan.

Geithner in a statement yesterday urged China to move toward a more flexible currency and said a series of meetings over the next three months will be “critical” to bringing policy changes that lead to a stronger, “more balanced” global economy. The delay comes as Chinese President Hu Jintao is scheduled to visit Washington for a nuclear summit April 12-13.

The Treasury chief faces demands from Congress to label China a currency manipulator for keeping the value of the yuan little changed from about 6.83 to the dollar for almost two years. Geithner is instead betting that China will take steps on its own in the next several months to strengthen its currency, analysts said.

“There is pressure within China for a yuan revaluation and, as long as exports continue to rebound, there is a good chance that it will happen,” said Elizabeth Economy, director of Asia studies at the Council on Foreign Relations in New York. “If, however, there is a lot of public pressure emanating from the U.S., that will likely give support to those in the Chinese government who do not want to see a revaluation.”

Geithner's statement is available here, and I must admit that I'm torn about this decision.  On the one hand, it's a good sign that the Obama administration is trying to use quiet diplomacy, as opposed to direct confrontation, to deal with the currency issue.  That's certainly a positive thing, as any aggressive unilateral response would probably (a) cause China to stubbornly delay RMB appreciation due to the government's paramount need to appear "strong" on the global stage; and/or (b) end up hurting American consumers and exporters.

On the other hand, I'm concerned that Geithner's move might be too clever by half.  By delaying the Treasury report, the US government still appears to be using it as a Damoclean sword to push China to appreciate its currency.  This move clearly turns the report into a US ultimatum tied directly to Yuan movement (i.e., "appreciate or else!"), rather than a regularly scheduled, legally-mandated bureaucratic event.  Will China be able to play this off without appearing to appreciate its currency in order to avoid American scrutiny that was specifically delayed to affect the Chinese decision?  I'm not so sure.  Second, I'm concerned that the administration is again "voting present" on a critical international trade/diplomacy issue.  Clearly, the White House is in a pickle here: cite China as a "manipulator" and end up doing more harm than good; or don't cite China and face the wrath of congressional protectionists, labor unions, and some US manufacturers.  But instead of making a strong, principled decision and then defending it to any and all critics (including some of their allies), the administration is punting.  Again.  Although this might be politically smart (but again, I'm not so sure it is), it's not exactly the face of confident international economic policy.   Thus, it's rather unclear to me that, while the report's delay is certainly expedient and better than the worst possible outcome (direct retaliation), it's overall a smart move by the Obama administration.

What is clear, however, is that the delay has (unsurprisingly) miffed congressional currency hawks like Sen. Chuck Schumer (D-NY), who took a moment out of his busy campaign schedule to express "disappointment" with Geithner's decision and to reiterate his skepticism that quiet diplomacy will lead the Chinese to eventually unpeg the RMB.  (Because bellicose unilateral retaliation will, like, totally work instead.  Rrrriiight.)  It's also increasingly clear that the Senator and his angry congressional colleagues simply have no clue what they're talking about when they confidently assert that RMB appreciation will magically and dramatically help the US economy and "save" American jobs.  The aforementioned Bloomberg article hints at this when it discusses how some of the strongest advocates for appreciating China's currency are Chinese businessmen:

Last month, Chinese executives, in interviews with Bloomberg News, joined in backing a stronger yuan, even as Premier Wen Jiabao says the currency isn’t undervalued.

Yang Yuanqing, chief executive officer of Beijing-based computer maker Lenovo Group Ltd., said gains would boost consumers’ purchasing power. Qin Xiao, chairman of China Merchants Bank Co., said an end to the yuan’s 20-month peg to the dollar would let lenders set market-based interest rates. Chen Daifu, chairman of Hunan Lengshuijiang Iron & Steel Group Co., said a stronger currency would cut import costs.

These statements indicate that, contrary to what Schumer and others claim, RMB appreciation could actually make Chinese producers more competitive, not less, because of (among other things) China's current role as a global assembly point and net importer of industrial inputs and raw materials.  Indeed, as Cato's Dan Ikenson noted in a recent Wall Street Journal op-ed, "Studies suggest that one-half to two-thirds of the value of 'Chinese' imports is added in other countries, including the U.S."  Thus, if/when the RMB appreciates, one-half to two-thirds of Chinese producers' total costs (the "import costs" that Chen Daifu references above) will actually decrease, thus improving (or maintaining) the overall competitiveness of exported Chinese products made from suddenly cheaper imported inputs.

Ikenson also points out several other facts which strongly argue that RMB appreciation could harm, not help, the US economy.  And it's because of these realities, and a few others, that Yale economist Ray Fair estimates that China's currency policies have actually benefited the American economy through a net gain of over 50,000 jobs.  (See this Phil Levy blog entry for a quick explanation of why Fair's analysis differs from, and is better than, all the job-loss wailing and gnashing by Paul Krugman and his fellow currency hawks.)

Normally, I'd say that the Chinese statements and the accompanying factual support strongly suggest that Schumer and his currency cohorts might want to pipe down about the evils of a pegged RMB and the miracles of any appreciation.  But we all know better than that.  As Schumer's statements about China trade, and those of other demagogues like Sen. Arlen Specter unequivocally demonstrate, the arguments coming out of Congress have nothing to do with economics, logic or sanity, and everything to do with getting re-elected.  So no matter what China does this year, it will remain many campaigning politicians' bogeyman until November 2010.  Guaranteed.

But that doesn't mean that we should just let them get away with it.  And I think that a good place to start is by simply letting these politicians know that the Chinese business community shares their intense desire for RMB appreciation.  With allies like those, it kinda makes you wonder who the Senators' enemies really are, huh?

PC4D: The Spoils of Protectionist Politics

I've often opined that placating anti-traders is a fools errand for politicians.  That rule applies, however, only to supporters of open markets and free trade.  Indeed, as today's news shows us, such unscrupulous pandering can actually reap huge political dividends for our elected protectionist, ahem, "leaders."

First, protectionism can provide a campaigning politician with the perfect bogeyman from which he can "rescue" his now-frightened constituents.  Consider this recent stump speech by everyone's favorite China-hater and the loudest sponsor of the Currency Exchange Rate Oversight Reform Act of 2010 (S. 3134), Sen. Chuck Schumer (D-NY):

China isn't playing fair when it manipulates its currency and it's time to fight back, U.S. Sen. Charles Schumer said today.

Standing before the Crucible Industries gate, Schumer, D-NY, announced that he and 15 Senate colleagues, Democrat and Republican, are cosponsoring a bill that would impose tariffs on Chinese goods if the Chinese government continues to peg its yuan artificially low against the dollar.

The bill would help fight a practice that is unfairly making Chinese goods cost less than competing American products, costing thousands of American jobs and hindering U.S. job creation, he said.

"The point we're making to the Chinese right here in front of Crucible Steel -- you don't play by the rules, we're going to make you play by the rules," Schumer said as Syracuse Mayor Stephanie Miner, Solvay Mayor Kathleen Marinelli, Crucible plant and union leaders and other business and political officials looked on.

International agreements call for countries to let their currencies float in value in relation to other currencies, Schumer said. Doing so restores some balance in international trade, he said.

By keeping its currency artificially low, China in effect makes its exports to the United States cheaper compared with U.S. products, Schumer said. It also make U.S. exports more expensive compared with Chinese goods, he said, making it harder for American companies to compete in China and globally....

The only argument against the proposal is that it could hurt efforts to get China to join the United States in diplomatic activity such as a boycott of Iran, Schumer said.

"Nothing is more important than jobs in America. If we don't keep our jobs here, if we don't have good-paying jobs, all the rest goes by the wayside," Schumer said.

"I don't think on this one there is a very cogent other side other than you might get the Chinese mad," he said. "You know what I say? Too bad."

What a tough guy!  (Stop snickering.)

Now, leaving aside Sen. Schumer's gross factual misrepresentations about the China currency issue, his stump speech provides us with a classic case of another type of Protectionist Campaigning for Dummies: what I'll call the "fake white knight."  Here, Schumer (who, in case you missed it, is up for re-election this year) demonizes a voiceless opponent in China by claiming that its pernicious, "unfair" trade practices are destroying good ol' American jobs.  He then claims that his legislation will "get tough" with, and thus save his constituents from, the evil strawman (China) that he just created!  (All with no downside, of course.)  Thus, in one little speech, Schumer creates an enemy, creates a solution, and promises to resist the naysayers and use his legislative solution to vanquish an enemy that he alone constructed.

Our hero!

And because only Schumer, his staff and the few unions/manufacturers in attendance know the actual facts of the issue (thank you, Public Choice Theory), and because no one dares stick up for the Chinese (lest they be called a supporter of "shipping jobs overseas"), the good Senator can demagogue China with impunity.  It's the perfect crime (against US consumers).

And as Sen. Arlen Specter (DRD-PA) proved today, this is one crime that does pay.  Handsomely.

Salena Zito at the Pittsburgh Tribune reports that Sen. Specter's re-election bid today picked up the all-important endorsement of the Pennsylvania AFL-CIO and all of the state's other labor unions:

The Pennsylvania AFL-CIO today endorsed Sen. Arlen Specter in the May 18 Democratic primary election, marking the fourth time in Specter's five terms he earned the labor organization's support....

After spending 30 years as a Republican and switching party affiliations, Specter has earned all of the major labor union endorsements in his primary race against U.S. Rep. Joe Sestak of Delaware County....

"Both Sestak and Specter came in and gave presentations to our board," said Bill George, Pennsylvania AFL-CIO president. "They both received standing applauses, but it was Specter who won two-thirds of the vote of our 54-member board."

George said an endorsement from the labor organization, which represents 900,000 workers, is tough to earn.

"The candidate has to get two-thirds of the vote; there have been times over the years where we have not endorsed."

I can't say I've ever heard of a politician getting a standing ovation and less than one-third of the vote, but hey, congrats Joe Sestak.  And in Joe's defense, he didn't really stand a chance here because he's not a Senator yet and can't sponsor protectionist legislation that anti-traders like the AFL-CIO just eat up with a fork, knife and collectively-bargained spoon.  I mean, is there any doubt that Senator Specter's recent protectionist pandering, including his sponsorship of the Unfair Foreign Competition Act of 2010 (S. 3080) and his loud support for carbon tariffs in Senate climate change legislation, helped secure that critical campaign endorsement?  (Obvious answer: Nope.)

So nice work, Senator!  You're the best panderer ever! 

Well, you and Chuck Schumer.

Is Schumer-Graham Consistent with WTO Rules?

When Sens. Chuck Schumer (D-Campaigning) and Lindsay Graham (R-Textile Industry) introduced the Currency Exchange Rate Oversight Reform Act of 2010 (S. 3134), one of the bill's big selling points was that, unlike previous currency bills, this one was, like, totally consistent with WTO rules.  For example, here's the United Steelworkers (USW) touting the bill's provisions which rewrite US law to apply countervailing duties (CVDs) on Chinese imports that allegedly benefit from PRC currency policies:

Significantly, the proposed act requires the U.S. Department of Commerce to investigate currency undervaluation as a countervailable subsidy under U.S. trade remedy laws. The USW believes a countervailing duty remedy is the simplest and most appropriate way to remedy the injurious effects of currency subsidies in a manner consistent with World Trade Organization rules.

While it's certainly true that S. 3134 abandons previous versions' most obvious WTO violation - a 27.5% tariff on all Chinese products that would expressly violate US commitments to apply tariffs in a non-discriminatory manner and below certain "bound" levels - it appears that the USW's statements about the new bill's legality are, to put it kindly, overly optimistic.

[OBVIOUS DISCLAIMER: The following is a quick-n-dirty review and in no way represents legal advice from me or my law firm.  Now back to the show.]

The legislation's new "duty" provisions are in Section 110 ("Currency Undervaluation Under Countervailing Duty Law"), and, even though the 27.5% tariff is gone, at least three immediate WTO problems stick out.  First, the legislation explicitly raises WTO concerns regarding the mandatory initiation by the Department of Commerce (DOC) of an investigation to determine whether a nation's currency policies are providing a countervailable subsidy (and thus potentially subject to remedial tariffs).  Section 110 also raises separate WTO concerns related to (1) whether currency policies are a "financial contribution" or "income or price support" by a government, and (2) the "specificity" of any subsidy conferred through such currency policies.  And here's where things get really interesting: the latter two issues, while essential components of any CVD determination, are actually absent from the legislation itself.  I opine below on why such elements could be missing; regardless of the reason, they raise serious legal questions.

Before we get to these issues, however, here's some necessary (and admittedly boring) background about the initiation of a CVD investigation and what constitutes a "countervailable subsidy" under US law.

• Initiation. Under US law (19 USC 1671a), DOC will initiate an CVD investigation in two circumstances: automatically or by petition. Where initiation is automatic (1671a(a)), DOC will initiate where it "determines, from information available to it, that a formal [CVD] investigation is warranted." For initiation by petition (1671a(b) and (c)), DOC will initiate where: (i) the evidence provided in the petition sufficiently alleges, based on available information, the elements necessary to impose CVDs under US law; and (ii) the petition is filed by or on behalf of the domestic industry. For (ii), "by or on behalf of the domestic industry" means the domestic producers or workers representing (a) 25 percent of the like product's production; or (b) 50 percent of the production of the portion of the industry expressing "support" for the petition.

• "Countervailable subsidy." There are three types of subsidies that may be countervailed under US law (19 USC 1677): (i) domestic subsidies, (ii) export subsidies and (iii) "import substitution" subsidies. A "subsidy" exists where DOC finds a (i) "financial contribution" or "income or price support within the meaning of Article XVI of GATT 1994" (ii) provided by a government (or entrusted/directed private entity) that (iii) confers a benefit upon the recipient.  That subsidy is only countervailable, however, if it is "specific" to an enterprise/industry.  While domestic subsidies require an express DOC finding of specificity, export subsidies ("a subsidy that is, in law or in fact, contingent upon export performance") and import substitution subsidies ("a subsidy that is contingent upon the use of domestic goods over imported goods") are automatically specific under US law (i.e., DOC need not find that the subsidies are specific to an enterprise/industry).   In these latter cases, however, DOC still must show that a subsidy exists, as per the three factors outlined above.

Now on to S. 3134's CVD provisions.  For the sake of brevity (stop laughing), I'm not going to excerpt all of Section 110, but you can read it here if you're a masochist.

The legislation amends Section 1671a(c) ("Petition determination") to force DOC to initiate a CVD investigation of currency "undervaluation" or "fundamental misalignment" where (i) a petition is filed by an "interested party" alleging the the elements necessary to impose CVDs under US law, and (ii) the petition is accompanied by sufficient information reasonably available to petitioner.  The bill does NOT, however, require that the petition be filed "by or on behalf of the domestic industry."  Thus, any interested party (like a union, perhaps?) can file a currency/CVD petition and DOC must initiate a CVD investigation even if the petitioner represents a tiny fraction of the total domestic industry involved.  Yikes.

Now, this change perhaps could have been intended to create a bizarre "hybrid" of the "automatic" and "by petition" methods of initiation, but because the bill amends 1671a(c), it must be read as a type of initiation by petition, not a type of "automatic" initiation (or some zany new form of initiation).  However, WTO rules - particularly Art. 11.4 of the WTO Subsidies (SCM) Agreement - require an examination of "industry support" where a CVD investigation is initiated by petition (using the same 25%/50% thresholds described in US Law).  Thus, it would appear that S. 3134, if enacted, probably violates Art. 11.4 of the SCM Agreement as such.

The legislation also addresses how to calculate the subsidy "benefit" during once DOC initiates a case and undertakes a CVD investigation.  Nothing overtly problematic in the benefit sections jumps out (although in practice there could be lots of problems, as Dan Ikenson notes here).  On the other hand, Section 110 is absolutely silent on (i) whether currency policy is a "financial contribution by the government" (and thus a "subsidy"); or whether (ii) any such subsidy is specific under US Law.  This is really important because S. 3134 fails to address two of the more challengeable aspects of any Law that would apply CVDs based on currency policy.

The reasons why these two aspects are so "challengeable" are very sound.  Let's consider them separately.

(1) Financial contribution or income/price support.  As noted above, US law requires that a subsidy entail an "income or price support under GATT Art. XVI" or "financial contribution."  The latter is defined in 19 USC 1677(5) as:

(i) the direct transfer of funds, such as grants, loans, and equity infusions, or the potential direct transfer of funds or liabilities, such as loan guarantees, (ii) foregoing or not collecting revenue that is otherwise due, such as granting tax credits or deductions from taxable income, (iii) providing goods or services, other than general infrastructure, or (iv) purchasing goods.

WTO rules (Art. 1 SCM) follow this language pretty closely.   GATT Art. XVI:1 includes as a subsidy "any form of price or income support, which operates directly or indirectly to increase exports from ... its territory."  Given these definitions, it is very questionable whether WTO rules would allow a national currency policy to be deemed a "financial contribution" or an "income or price support" because currency policies don't meet any of these key terms' express criteria.  Indeed, most independent analysts - like this recent CRS Report on the issue - believe that it would be a real stretch to deem currency manipulation a financial contribution.

(2) Specificity and prohibited subsidies.  WTO rules take a slightly different approach from US law regarding specificity and export subsidies or import substitution subsidies.  Article 2.1 of the SCM Agreement defines specificity ("specific to an enterprise or industry or group of enterprises or industries") and sets forth guidelines for specificity as a matter of law or fact.  Article 2.3 adds that "Any subsidy falling under the provisions of Article 3 shall be deemed to be specific."  Under Art. 3 of the SCM Agreement, export subsidies and import substitution subsidies are prohibited outright.  Art. 3.1(a) defines export subsidies as "subsidies contingent, in law or in fact, whether solely or as one of several other conditions, upon export performance, including those illustrated in Annex I."  Art. 3.1(b) defines import substitution subsidies as "subsidies contingent, whether solely or as one of several other conditions, upon the use of domestic over imported goods." Given these definitions, there is clearly a huge question as to how a nation's currency policy is "specific" to an enterprise/industry or a "prohibited subsidy" under WTO rules because a nation's currency is available to all citizens and not contingent upon exportation or import substitution.  (The CRS Report cited above also concurs with this reading.)

Because of the obvious concerns surrounding financial contribution and specificity in any CVD/currency legislation, both of these issues have been raised by critics of such bills' previous iterations.  However, the earlier bills (like S. 1027, introduced by Sens. Sherrod Brown (D-USW) and Debbie Stabenow (D-UAW) in May 2009) typically mandated that currency manipulation (or "misalignment" or "undervaluation" or whatever) expressly constituted a financial contribution, and an automatic export subsidy under US law.  The bills thus obviated the question of how DOC would find financial contribution and specificity, but they raised immediate and explicit WTO concerns under Articles 1 through 3 of the SCM Agreement.  S. 3134, on the other hand, does not address these issues at all and instead just punts the controversial issues to DOC.  And, as noted above, supporters of the bill just-so-happen to be publicly selling the new Schumer/Graham as being more WTO-compatible than past versions.  (How conveeenient!)

Given this background, it seems quite possible that S. 3134's significant omissions were expressly intended by the drafters to (i) avoid immediate scrutiny by the bill's opponents of previous CVD bills' most questionable provisions under WTO rules; (ii) provide the bill's co-sponsors with "cover" should any scrutiny arise; (iii) gain support for the bill among Senate colleagues; and (iv) maybe even delay a formal WTO challenge if the bill ever became US law.

Sneaky sneaky!

I should note that point (iv) here is quite arguable, as a WTO Member could still claim that the bill establishes "measure" that has a "prospective effect" which violates WTO rules (See, e.g., US-Continued Zeroing (AB)).  In particular, a WTO Member would argue that no financial contribution or specificity can possibly exist in the case of the countervailing duty investigations of WTO Members' currency policies that the measure (S. 3134) requires.  Such an approach not only is probably ok under WTO rules, but also is just plain ol' common sense: if I pass a law that targets redheads for taxation and mandates what to do with the "redhead revenues," but doesn't expressly direct the government to collect a tax from redheads, that doesn't mean that the law doesn't tax redheads.  Duh.

However, any such WTO challenge could not be based on the simple letter of the law itself, which merely requires DOC to initiate an investigation and provides a benefit methodology for any such investigation. Thus, one could easily see the bill's drafters purposely leaving the offending financial contribution and specificity provisions out of S. 3134 in order to achieve goals (i) through (iv) above.  But our elected representatives would never do something so surreptitious and misleading, right?

Rrrrrrriiiiiiiiiiiiight.

(They're still probably going to run into explicit WTO problems with those mandatory initiation provisions, but those are relatively new additions to the currency bills and definitely not as publicized/scrutinized.)

It is easy to see why the Senators' might want to avoid this scrutiny during debate, and how the lack of express WTO vulnerability on financial contribution and specificity could be a selling point to other Senators. However, shelter from immediate WTO challenge (assuming it happened, which again is far from certain) would also be quite valuable to the S. 3134's supporters, including those unions and domestic companies seeking protection from Chinese imports.  If a WTO Member actually held off on immediately challenging the new law at the WTO, the Member's next "concrete" opportunity would only come after the law is applied - i.e., after DOC had preliminarily determined in a CVD investigation that a countervailable currency subsidy existed by establishing a methodology for financial contribution and specificity.  Given the typical timeframe for drafting a petition and issuing a preliminary determination, DOC's first preliminary determination on currency subsidies could take a year or more from the law's enactment.  In the meantime, the new law's initiation provisions could lead to a flood of new CVD petitions/investigations and thereby immediately affect (read: harm) the commercial behavior of many Chinese exporters.  Thus, domestic petitioners could have a one-year "buffer" between the law's enactment and WTO challenge.  Petitioners would also be able to keep filing petitions for several more years as the original WTO challenge is litigated.  And consumers, of course, would be helpless to stop any of it.  Oh goody.

While this all may sound far-fetched, a very similar scenario actually occurred in the China/CVD/Non-market economy (NME) cases in 2006-07.  Despite the filing of a CVD/NME petition and years of political pressure to begin applying CVDs to "non-market economies," China only brought a formal WTO challenge on the issue after DOC's preliminary determination in the first CVD case (Coated Free Sheet Paper - full disclosure: my firm litigated this case on behalf of the Chinese exporters).  The WTO dispute was dropped when the International Trade Commission issued a negative final determination, but China has since filed another WTO complaint that is currently pending and won't be final (assuming the US appeals) for several more years.  Meanwhile, many other China/CVD petitions have been filed, and many countervailing duties are currently in place against Chinese imports.  Although the China/CVD case differs from the currency matter because US law was totally silent on the matter (as opposed to S. 3134 expressly amending the law), it's possible that the Schumer-Graham drafters were hoping for just such a "delayed" outcome, given (i) the past experience of the bills' drafters with intense criticism about the WTO-inconsistency of their CVD/currency bills; (ii) the S. 3134's blatant omission of any language on financial contribution or specificity; and (iii) the recent experience with the China/CVD cases in the United States.

So there you go.  Isn't US trade remedies politics fun?  Ok, fine, maybe not, but it's still critically important to recognize how professional protectionists like Schumer, Graham and the AFL-CIO try to game the system in order to quietly push their agendas and to mislead the public about the costs and implications of their suggested policies.

Sen. Schumer: "This Fake China Study Like Totally Proves You Should Vote for Me!"

I was hoping tonight to do a quick-n-dirty review of whether the latest legislation attacking China for its currency policy - the Currency Exchange Rate Oversight Reform Act of 2010 (S. 3134) - violated WTO rules.  But alas, that will have to wait until tomorrow because the legislation's loudest sponsor, Sen. Chuck Schumer (D-Fear), is cooing like a giddy little sinophobic schoolgirl about a new "study" by the Economic Policy Institute which "shows" that "unfair China trade," particularly China's currency "manipulation," has "cost" US "jobs."  (Ed. note: quotes intended to convey the author's extreme sarcasm.)

According to EPI, the United States has lost 2.4 million jobs because of China's trade practices, and Sen. Schumer, you see, is gonna milk that sucker for all she's worth, baby::

Since 2001 America's lost 2.4 million manufacturing jobs because of our trade gap with China, which has ballooned due to China's undervalued currency. We cannot ignore the impact of these jobs anymore.  Right now one in ten workers is out of a job in America - 15 million Americans. This report shows that if China were playing by the same rules as the U.S. 2.4 million of those workers might be collecting paychecks instead of job hunting."

He then added:  “These [EPI] figures exceeded even our worst expectations.”  (Cue ominous music.)

Now, I've laid into EPI before, and briefly commented last night on the "think tank's" new anti-China publication, so I really thought that'd be the end of it.  But considering how tense and unstable the current US-China trade relationship is, and considering that China's currency policies are one of the main sources of that tension/instability, and considering that Sen. Schumer is using EPI to push his antagonistic currency legislation, I think it's absolutely necessary to point out tonight just how awful Sen. Schumer's loud reliance on EPI's work really is.

So here we go.

First, let's drop a little knowledge about EPI itself.  Did you know that it's board of directors is manned by nine of the biggest union poo-bahs on earth?  Andy Stern (SEIU)?  Check!  Richard Trumka (AFL-CIO)?  Check!  Ron Gettelfinger (UAW)?  Check!  Leo Gerard (USW)?  Check!  The list literally goes on and on.  EPI also receives about 30% of its annual funding from labor unions.  So it's union-run and union-funded.  And guess who is the primary force against free trade in the United States.  That's right - the unions.  And guess who just loves to use EPI's numbers to push its pernicious protectionism.  Yep - same guys.  So the unions fund and run EPI and then turn around and cite their anti-trade stats as if they come from some reputable, unbiased DC think tank.  Yeah, that's not sketchy at all.  Uh huh.

Now why do you think that the good Senator failed to mention these important little nuggets?

Next, let's look back at EPI's track record when it comes to other "studies" about trade and US job losses.  As I said a few months back:

The problem is that the EPI's numbers are nonsensical, and their basic methodology - simplistically tying the US trade deficit to US job losses - has been routinely debunked for almost a decade.  On the latter point, Cato's [Dan] Griswold (in, among others, 2000, 2001, 2003, 2005, and again in 2007 (PDF)), AEI's Phil Levy (here), the US Chamber of Commerce (here), FactCheck.org (here) and even your humble correspondent (here, with Cato's Dan Ikenson) have completely destroyed EPI's methodology.

For some intensive economic criticism on why EPI's models are so ridiculous, go here (and scroll to the middle of the page).  Indeed, Griswold just yesterday mocked EPI by pointing out how recent events blow a massive hole in their buffoonish system:

In years when the trade deficit was rising, it was common practice for the labor-union-friendly Economic Policy Institute to publish detailed studies showing that larger trade deficits caused the U.S. economy to lose hundreds of thousands of jobs each year. For example, according to an October 2008 EPI paper, rising non-petroleum trade deficits from 2000 to 2006 caused a lost of 484,400 jobs per year, while the shrinking deficit in 2007 lead to the creation of 272,500 jobs.

By the EPI’s own internal logic, the past two years should have been a boom time for job creation. Between 2007 and 2009, the non-petroleum trade deficit dropped by $174 billion as the sagging domestic economy cut demand for impost. If that was good news for jobs, somebody forgot to tell the U.S. labor market. Since the end of 2007, the U.S. economy has shed a net 8 million jobs.

Oops, maybe it’s time for EPI to rework its model.

That shrinking 2009 trade deficit kinda makes you wonder why EPI's latest China study, which (again) uses the trade balance to determine "job losses," only goes through 2008, huh?  Actually, no it doesn't.  You see, as Griswold's conclusion above makes clear, EPI is a laughingstock in this town, and pretty much everyone with access to the interwebs knows that their studies are, as the kids say, beat.  Except Sen. Schumer, of course.  Now how could a United States Senator, and his massive staff, fail to just Google EPI and find such widespread, longstanding criticism before trotting out EPI's latest masterwork to support the Schumer/Graham currency legislation?  That's so weird.

And then there's the loud smackdown that EPI's latest China study received today from multiple sources.  First, is the US China Business Council, which (if I don't say so myself) repeats a lot of the stuff I've been saying for a while about protectionist myths and China's currency:

An updated study released yesterday blaming widespread US job losses on trade with China is again based on flawed analysis and distracts from the real challenges facing the US economy and the trade relationship with China, the US-China Business Council (USCBC) said today.

"The Economic Policy Institute's latest study, 'Unfair China Trade Costs Local Jobs' is once again built on the faulty assumption that every product imported from China would have been made in the US otherwise. As I said two years ago, this assumption is clearly wrong--several decades wrong, in fact," said John Frisbie, USCBC's president....

"Much of what we import from China replaces imports from other countries, not products we make in the US today. A jobs impact study that ignores the facts undermines its own credibility."

As of the end of 2008 (the latest data available), the United States was the world's largest manufacturer--and likely remains so today. US manufacturing jobs, on the other hand, have been in a long decline over the past four decades, long before China came on the scene, and now constitute about 9 percent of total US employment.

"The main reason for the decline in manufacturing jobs is productivity, not China. The US makes more with fewer people, primarily because of productivity and technology advances," continued Frisbie....

US exports to China in 2009 were just under $70 billion, about the same amount as in 2008. US exports to the rest of the world in 2009 declined by 19 percent. "China outperformed in a down year," said Frisbie. China remains the third-largest export market for US goods, after Canada and Mexico, and has been the fastest growing market for US goods over the past decade.

EPI's focus on changing China's exchange rate to reduce the US trade deficit is equally flawed, Frisbie noted. "Yes, China needs an exchange rate that better responds to China's global trade flows. But China's exchange rate is probably not as significant a factor in the US trade deficit that some make it out to be."

China's currency appreciated nearly 20 percent between 2005 and the start of the global recession in 2008, when PRC monetary authorities stopped exchange rate movement because of the developing uncertainty in the financial markets. During the period of significant renminbi appreciation, the US trade deficit with China continued to grow, underscoring the limited relationship between the exchange rate and the trade deficit.

And then there's Ikenson again who angrily blogs:

EPI’s methodology (to use the term loosely) is not to be taken seriously, though, because it derives from a simple formula that approximates job gains from export value and job losses from import value, as though there were a straight line correlation between the jobs and trade data. It pretends that there are no jobs created when we import, and that import value is somehow an appropriate measure of job loss.

The flaws of those assumptions are many, but perhaps the easiest one to convey is that most of the value embedded in imports from China is not Chinese....

According to the results from a growing field of research, only about one-third to one-half of the value of U.S. imports from China comes from Chinese labor, material and overhead. Official U.S. import statistics—which pay no heed to the constituent value-added elements—therefore overstate the Chinese value in those imports by 100 to 200 percent, on average. The cited job loss figures are based on import values that are unequivocally overstated because one-half to two-thirds of that value are the costs of material, labor, and overhead added in other countries, including the United States.

What is seldom discussed—because they are often portrayed as victims—is that large numbers of American workers are employed precisely because of imports from China. This is the case because the U.S. economy and the Chinese economy are highly complementary. U.S. factories and workers are more likely to be collaborating with Chinese factories and workers in production of the same goods than they are to be competing directly. The proliferation of vertical integration (whereby the production process is carved up and each function performed where it is most efficient to perform that function) and transnational supply chains has joined higher-value-added U.S. manufacturing, design, and R&D activities with lower-value manufacturing and assembly operations in China. The old factory floor has broken through its walls and now spans oceans and borders.

Though the focus is typically on American workers who are displaced by competition from China, legions of American workers and their factories, offices, and laboratories would be idled without access to complementary Chinese workers in Chinese factories. Without access to lower-cost labor in places like Shenzhen, countless ideas hatched in U.S. laboratories, that became viable commercial products and support hundreds of thousands of jobs in engineering, design, marketing, logistics, retailing, finance, accounting, and manufacturing might never have made it beyond conception because the costs of production would have been deemed prohibitive for mass consumption. Just imagine if all of the components in the Apple iPod had to be manufactured and assembled in the United States. Instead of $150 per unit, the cost of production might be double or triple or quadruple that amount.

Consider how many fewer iPods Apple would have sold, how many fewer jobs iPod production, distribution, and sales would have supported, how much lower Apple’s profits (and those of the entities in its supply chains) would have been, how much lower Apple’s research and development expenditures would have been, how much smaller the markets for music and video downloads, car accessories, jogging accessories, and docking stations would be, how many fewer jobs those industries would support and the lower profits those industries would generate. Now multiply that process by the hundreds of other similarly ubiquitous devices and gadgets, computers and Blu-Rays, and every other product that is designed in the United States and assembled in China from components made in the United States and elsewhere....

EPI’s work on this subject provides fodder for sensational stump speeches. But it is also a major disservice to a public that is hungering for truth, and not self-serving advocacy masquerading as truth.

Other wonks had similarly unpleasant things to say about the EPI study, but hey, you don't need to be a wonk to see just how silly EPI's work really is.  Just look at the numbers themselves.  Without counting a single actual job, the EPI China study showed that by 2008 trade with China had cost the District of Columbia 3100 jobs (thank god I was spared!) or the folks in Santa Clara County 26,900 jobs.  And, as the study's dastardly little footnotes make clear, EPI's numbers are even more exact because they're rounded.  Again, without counting a single job.  Such pseudo-economics makes the White House's Stimulus* job numbers look Nobel-worthy by comparison, and it's so ridiculous that it should be rejected on its face.  Indeed, because most sane people probably would reject their argument if the exact number were used, EPI did that rounding.  It sounds more plausible that way, you see?  Unfortunately, as the analysis above makes clear, it ain't.

Yet despite the clear union-rigging, the history of EPI incompetence, the myriad recent criticisms, and all the failed smell-tests, Sen. Chuck Schumer waves the EPI study around like it's the Gospel and uses it to aggressively push legislation that could legitimately ignite a trade war between the United States and its second largest trading partner.  Now why on earth do you think he'd do that?

A cynic might say that it's because Schumer's up for re-election this year and has a long history of demagoguing China when he's campaigning.  But a United States Senator wouldn't knowingly use a nonsensical, union-funded study from a long-debunked organization to push controversial legislation that could destroy a $400 billion dollar trade relationship and millions of (real) American jobs, now would he?

As that cynic might say, yes.  Hell yes.

Apparently, Logic Has No Place in the China Currency Debate

It must be a day ending in "Y," because everyone's favorite China sheriff, Sen. Chuck Schumer (D-Campaigning), and his sinophobic Barney Fife, Sen. Lindsay Graham (R-Textile Industry), are yelling about China's currency regime.  This time, they've joined forces with anti-trade crusader Sen. Sherrod Brown (D-USW) to introduce newmostly-recycled legislation (the "Currency Exchange Rate Oversight Reform Act of 2010" - bill number & text currently unavailable) that would, among other things, change US law in order to force the US Department of Commerce and US Treasury Department to aggressively fight China's monetary policy:

[The legislation would c]reate a new approach to identifying currency manipulators by requiring that the Treasury Department base its determination strictly on objective measures related to currency exchange rates. Under current law, Treasury also has to determine that the misalignment is a willful attempt to gain a trade advantage before it can cite the country. The new legislation would eliminate the need to show intent....

The legislation requires Treasury to develop a biannual report to Congress that identifies two categories of currencies: (1) a general category of “fundamentally misaligned currencies” based on observed objective criteria and (2) a select category of “fundamentally misaligned currencies for priority action” that reflects misaligned currencies caused by clear policy actions by the relevant government....

The legislation clarifies that the Commerce Department already has authority under U.S. law to investigate whether currency undervaluation by a government provides a “countervailable subsidy” and must do so if a U.S. industry requests investigation. In recent years, the Commerce Department has been reluctant to exercise its authority under the law. This legislation, therefore, seeks to strengthen and reaffirm existing law and the Commerce Department’s obligations under the law.

The legislation also makes it clear that the Commerce Department is required to investigate currency undervaluation as a “countervailable subsidy” if Treasury designates a “priority” currency and a U.S. industry requests an investigation....

Sigh. I've already spent too much time explaining how the current debate surrounding China's currency policies is just rife with misleading statements from those who, for often unseemly reasons, breathlessly yearn for the United States to "get tough" with China and to "force" the Chinese to "restore fairness" to the bilateral trading relationship.  I've explained how China's currency, the renminbi (RMB), might not actually be as undervalued as the currency hawks claim.  I've provided ample historical and economic evidence demonstrating that a significant RMB appreciation probably won't dramatically affect US-China tradeflows or the US manufacturing sector.  And I've even tried to show how guys like Chuck Schumer love to baselessly demagogue China (or before that, Japan) in election years (and gee, guess who's up for re-election this year?) as an easy way to get free media and literally scare up votes.  On this last point, I'll soon delve deeper into the political pandering/misinformation that Sens. Schumer, Graham and Brown have used to support their new anti-China legislation (as part of my "Protectionist Campaigning for Dummies" series).  So stay tuned for that.

For now, however, I just want to make two quick and easy points.  First, Cato's Dan Ikenson does a great job today summarizing the best economic arguments against doing anything on the China currency issue, especially when your express goal is to affect the US-China trade balance.  I've covered a lot of this before, but this is a really good synopsis, so here you go:

Between July 2005 and July 2008, the Chinese RMB appreciated by 21 percent against the dollar.  But over that 3-year period, the U.S. trade deficit with China increased from $202 to $268 billion.  Why, then, do policymakers think revaluation is the key to reducing the trade deficit?  Why do they even care about the bilateral trade deficit, which is meaningless in the context of our globalized economy.  Only one-third to one-half of U.S. imports from China is Chinese value added.  The rest is Japanese, Taiwanese, Korean, Australian, American and other countries’ value added.  The bilateral figures tell us nothing important.

During the aforementioned period of RMB appreciation, U.S. exports to China increased by $28 billion.  But U.S. imports from China increased by $94 billion.  Americans continued to purchase Chinese imports–despite the currency-induced price increase–for two primary reasons.  First, there aren’t many substitutes for the Chinese products U.S. consumers tend to purchase.  Second, Chinese exporters, by virtue of a stronger RMB, were able to reduce their costs of production because many of those costs are for imported inputs (made cheaper because of the stronger RMB), which subsequently enabled them to lower their prices for export to the United States.

Ikenson's upcoming paper on China should provide a lot of other good data and argument, so be on the lookout for that.

Second, I have just one simple question for all of those protectionists, like a certain New York Times columnist, who are currently demanding that (a) the Treasury Department label China a "currency manipulator" in its semi-annual report on the subject, and/or (b) the Commerce Department reverse years of practice and deem "currency manipulation" to be a countervailable export subsidy under US Trade Law:

If Chuck Schumer, Lindsay Graham and Sherrod Brown - the Senate's most aggressive China currency hawks - believe that they need to change US law in order for Treasury and Commerce to respectively find "manipulation" and "subsidization," then why on earth should anyone believe protectionists' confident assertions that China's actions are patently illegal under existing, un-amended US law?

Seriously, how does this make any sense?  In essence, Schumer and his cronies are saying, "Hey, Geithner and Locke, you better find China's policies illegal under current law, or else we'll change the law so that they're illegal."

What the $#%&*?

Then again, considering how steadfastly and routinely the China demagogues ignore all the, you know, actual facts about China, currency, manufacturing and the bilateral trade deficit, logic obviously has no place in this debate, now does it?