Would A Trade War Happen Due To China's Low Yuan Policy?

On ABC News: China Warns US Against Sanctions Over Currency

• China's commerce minister warned the United States on Sunday against imposing trade sanctions over Beijing's currency controls, and said his country was likely to report a trade deficit in March.
  
  Washington and other trading partners are pressing China to ease controls that have kept its yuan currency steady against the dollar for 18 months to help its companies compete amid weak global demand. Some U.S. lawmakers have demanded to have China declared a currency manipulator in a U.S. Treasury Department report due out next month, which could precede possible trade sanctions.
  
  Asked what measures China would adopt if the Treasury Department declared it a currency manipulator, Chinese Commerce Minister Chen Deming said China would not sit idly by and reiterated Premier Wen Jiabao's statement a week ago denying that the yuan was undervalued.
  
  "If (the Treasury Department's) reply is accompanied by trade sanctions and trade measures, we will not ignore it," Chen said. "If it is followed by any international legal lawsuit against China, we will take them on."
  
  Business groups say China's currency controls keep the yuan undervalued by up to 40 percent, giving its exporters an unfair price advantage and swelling its multibillion-dollar trade surplus.
  
  Chen dismissed charges that exchange-rate controls are the cause of the surplus, blaming instead U.S. restrictions on exports of certain goods to China, such as high-tech items that could have both civilian and military use. Chen also said the U.S. had politicized the currency dispute and exaggerated the level of the trade surplus between the two countries....

Getting rather dicey or do you think everything is so politicized?

Professor Pettis had this article: How will an RMB revaluation affect China, the US, and the world?

Some excerpts:

• These are murky political waters into which I do not want to dip, but it is hard to escape the politics of the debate. The same issue of the People’s Daily had another article pointing out that US debate on the currency was driven mainly by domestic considerations and that the only reason Obama brought up the subject of the RMB was to address domestic polls.
  
  “The U.S. government wishes to eliminate trade deficit and ease its high unemployment rate by pushing yuan appreciation. That was only its wishful thinking,” said Yi Xianrong, an expert with Chinese Academy of Social Sciences (CASS).
  
  …The saying that “undervalued yuan leads to global trade imbalance” cannot stand up to close scrutiny. Zhao Qingming, a researcher with China Construction Bank stressed that imbalance of an economy’s deposit and investment was the fundamental reason for trade surplus or deficit. Exchange rate has only minor influence. In fact, yuan appreciation brings more adverse effects to western countries than positive ones. In the past tens of years, because of the yuan devaluation and export rebate policies, western countries, to a large extent, were able to enjoy low inflation, low living cost, and current standard of living, and western governments were able to reduce financial deficit and allow their people to consume excessively.
  
  There is, as always, a certain amount of nonsense in these articles. For example the exchange rate itself affects the ratio between savings and investment, so while the first part of Zhao’s statement is more or less right — although not as a “fundamental reason” but rather as part of an accounting identity — the second part is certainly wrong and probably meaningless. More interestingly, it seems a little weird to argue that one of the benefits that China has provided the world with its undervalued exchange rate is low consumer prices that allow countries like the US “to consume excessively”. Aside from the fact that this pretty explicitly acknowledges that the currency is undervalued, since excess consumption is exactly the problem in the US, and since Chinese per capita consumption is much less than 10% of that of the US, it seems that China should be more approving of US attempts to return the favor and allow Chinese consumers the benefit of subsidized US prices.
  
  Everything is politicized
  
  Still, I do think the People Daily’s article is right to say that the RMB is becoming an important domestic issue for Obama, and that it is domestic US politics that is driving much of the recent noise and the rancor. Obama’s popularity has dropped considerably, and ahead of the upcoming elections he needs to show that he is addressing fundamental economic problems. And of course it is also always easy to get votes by bashing foreigners — this is one of the many attitudes that the US and China share.
  
  But even though the People Daily’s criticism is correct, perhaps that doesn’t change anything meaningful. The concern over the effect of the RMB on US employment may still be a perfectly valid one, and the fact that Obama is under domestic pressure to address the currency is not an especially good reason to dismiss his concerns. On the contrary. Obama has little wiggle room, and as Paul Krugman pointed out in a fiery, and probably influential, speech last Sunday, the US may hold the stronger cards in any showdown. According to the relevant article in Business Week,
  
  Krugman said China’s currency policy has a “depressing effect” on economic growth in the U.S., Europe and Japan, as measured by gross domestic product. If China’s currency, the yuan, were not undervalued, it would have a “significant” impact on the global recovery, he said. “If we could get some change in China’s currency policy, it would help the world,” Krugman said today at an Economic Policy Institute event in Washington.
  
  …Krugman said the world economy wouldn’t be hurt, and could benefit, if China were to sell off a large portion of its dollar-denominated assets. He said that if China were to sell all of its U.S. investments, it would help the economy by acting as a form of quantitative easing and fighting a “liquidity trap” that has recently been affecting the U.S. economy.
  
  “We should not be afraid of what the Chinese might do if we pressure them to stop this currency manipulation,” Krugman said. At the end of 2009, China was the top foreign investor U.S. government debt, with holdings of $898.4 billion in Treasury securities. Krugman said the U.S. may need to get more aggressive in its negotiations with China, perhaps by treating the exchange- rate issue as a countervailing duty or other export subsidy. “Without a credible threat, we’re not going to get anywhere,” he said. “The chance that we would trigger a trade war is very small and it’s hard to see any alternative.”
  
  Krugman elaborated further Monday in the New York Times in an article, and then in a follow up article Wednesday, both of which are likely to be much quoted and widely read. Although Premier Wen noted again in his speech Sunday that China is “worried” about the value of its US dollar reserves, perhaps as a warning that China would counteract any US trade move by selling off USG bonds, Krugman doesn’t seem especially worried about this threat.
  
  He may be right. Aside from the fact that it is not clear how China can dump Treasury bonds, he claims that it would only help the Fed in its quantitative easing, and would probably do far more damage to Europe (since China would presumably have to buy euros) than to the US.
  
  The latter point is almost certainly correct. China’s selling dollars and buying something else would allow the US to get even more bang for its protectionist buck, probably at poor Europe’s expense. I would also add that the main long-term impact of dumping USG bonds might be no more than to cause a liquidation of Chinese assets at very low prices, and an equivalent transfer of wealth from China to the US (or to others likely at some point to buy cheap dollar assets).
  
  Remember that at the beginning of WW1 something similar happened. In an urgent attempt to raise gold reserves to pay for the war, in the late summer of 1914 European belligerents dumped onto US markets what amounted to a far greater share of US assets than China currently holds. This caused about six months of havoc, and many sleepless nights in New York and Washington. But the US responded by putting into place temporary capital and stock market controls, and when the dust settled, the net effect was one of the most massive short-term transfers of wealth ever recorded from one group of countries, the European belligerents, to another, the US. European dumping caused a collapse in prices, and US investors ultimately scooped up the assets up very cheaply.
  
  That doesn’t mean that there will be no cost for the US if China dumps, but rather that the cost might be absorbed fairly comfortably over a reasonable time period. I suppose I will be very unpopular for pointing this out — especially with people in the US Treasury department and among Chinese cold warriors — but please don’t blame the messenger. I am just trying to use the limited historical precedents to figure out what is likely to happen. We have seen asset dumping before, and on an even larger scale, and the US capital market is deep enough that it might easily absorb it.
  
  Where I disagree with Krugman is with his claim that the chance of triggering a trade war is small. In fact, the day Krugman published his article, 130 US Congressmen sent an open letter to secretaries Timothy Geithner (Treasury) and Gary Locke (Commerce) demanding that China be designated a currency manipulator. They called for duties to be imposed on Chinese imports to counter the effect of the undervalued RMB. This raises pressure significantly, and I am sure in the next week or two there will be a lot more. There are also strong rumors of some high-powered and relevant Congressional session next week. Stay tuned.
  
  Of course regular readers of my blog won’t be surprised by any of this. The logic behind a prediction of trade war is almost unchallengeable, and the two countries are simply the two most visible in a world in which trade tensions must inexorably rise. Just ask the Germans and their European partners. Trade relationships will continue to get much worse, largely because the cost of trade war for high-deficit countries is so much lower than for high-surplus countries, and there seems to be no real attempt on either side to tone down aggressive actions or rhetoric. We seem to be caught in a downward spiral, and the longer it goes on the harder it is for anyone not to participate.
  
  But while I think the economic effect of a tariff war on the US is likely to be smaller than many expect (and much smaller than that indicated by some of the outraged yelping I saw on a CNBC show dedicated to the subject today), and maybe even employment-positive in the short term, I do not think it is in the longer term interest of the US. I think trade war would be very painful for China, and forcing them into such a difficult position will poison the relationship for many years. This is likely to be the most important global relationship of the next few decades, and we really need a better way to resolve these very thorny issues, but that almost certainly isn’t going to happen.
  
  To return to the People’s Daily article, I think many in China have argued that a revaluation of the RMB may have a significant effect on China’s trade surplus without having an equivalent effect on the US trade deficit. The same would be true of tariffs on Chinese goods. In either case, say many in Beijing, China loses, but the US doesn’t gain, so why is the US so determined to force this outcome?
  
  Read the rest of the article here

Past postings on Trade Protectionism:

• Trade Protectionism Issue Highlighted
• Would Current Trade Protectionism Issue Hinder Global Financial Recovery?
• Canada Continues Its Protest Against 'Buy American' Policy
• Buy Chinese Vs Buy American