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?

Friday Quick Hits

Lots of small things going on today worth noting:

• US promises world that it'll comply with WTO rulings on "zeroing"; world calls bulls**t.  BNA (subscription) reports that, at a March 3-4 WTO negotiating meeting, the United States was telling anyone who would listen that it, like, totally intends to comply with a bundle of WTO rulings against its use of “zeroing” in antidumping investigations.  As you might recall, "zeroing" artificially (and, of course, illegally) inflates dumping margins (duties) on foreign goods, and the US has refused to fully comply with the aforementioned WTO decisions where they involve reviews of existing antidumping orders. (They're complying with decisions involving original investigations.)  Given these facts, WTO Members are rightly skeptical of the US claims: “We are concerned about a usual cosmetic change which would be far from compliance,” said one overly-polite WTO official.  Unofficial translation: "Riiiight. You're totally going to issue some fake 'change' that still ends up screwing our exporters." Meanwhile, both the EU and Japan are proceeding along the long and winding legal road to retaliating against US exports because of American non-compliance on zeroing - to the tune of about $311 and $248.5 million, respectively.  Awesome.

• Schumer makes it official: it's re-election season.  The Wall Street Journal reports that Senator Charles Schumer (D-Campaigning) and three other awesome Democrat Senators (Brown, Casey and Tester) have proposed legislation - the "American Renewable Energy Jobs Act" - that would block the Energy Department from using stimulus funds to subsidize wind-energy projects that use foreign-made turbines. Their main target is a proposed wind-energy project in Texas where the backers plan to use wind turbines made with Chinese components.  Of course, while the Senators chest-thumped about China, they curiously omitted that: (i) the targeted Texas company hasn't even filed for Stimulus* funding yet; (ii) the legislation is vigorously opposed by both Energy Secretary, and fellow Democrat, Steven Chu ("You do not want to stop these projects if two-thirds [of the hardware] is American and one-third is foreign.") and the primary beneficiaries of such legislation - the American Wind Energy Association ("[A]pproximately 40,000 American jobs were saved by [Stimulus*-funded wind] projects.... The Schumer proposal would shut the program down... because no wind developer could meet the strict requirements of the Schumer Buy American amendment--the United States simply does not have the manufacturing capacity yet to produce 100% of the turbine parts."); and (iii) as I noted a while ago, the demonized Chinese products contain lots of US (and German) components.  But hey, Schumer's up for re-election, and China demagoguery is one of his signature campaign moves, so facts be damned!

• There's a new sheriff in town, and he's not a big fan of those pending FTAs.  Due to serious ethical concerns, Congressman Charlie Rangel (D-NY) is now on "temporary leave of absence" from his  chairmanship of the House Ways & Means Committee - the primary House committee that deals with US trade issues and the only House committee that must, by law, review any of the pending FTAs with Colombia, Panama or South Korea before the Houses vote on them.  Rep. Sander Levin (D-UAW) will replace Rangel, and, as Reuters reports, he's not a big fan.  Granted, I didn't think that these FTAs were going anywhere in 2010 anyway, but this change should pretty much seal the deal.