The New China Syndrome

The Chinese executives were in New York City for a week of business-school classes. Even before economist Glenn Hubbard--dean of Columbia Business School and former chief of President Bush's Council of Economic Advisers--finished teaching on Monday morning, it was clear that his students had done their homework.

Hubbard gave his mostly positive take on the state of the global economy, then asked for questions. Richard Feng, CEO of furniture maker Markor, went straight to issue No. 1 in U.S.-China economic relations: the ever louder demands from Capitol Hill that China let its currency rise as much as 40% against the dollar. That would, in theory at least, make Chinese products more expensive in the U.S. and U.S. products cheaper in China. Americans would buy less, the Chinese would buy more, thus reducing the huge trade imbalance between the countries-- $20 billion in May alone and $233 billion in all of 2006. This deficit is a big political issue in America's industrial heartland, where China gets the blame for a 19% drop in manufacturing employment since 2000.

But U.S. consumers benefit from cheap manufacturing in China, Feng argued through an interpreter. When Japan gave in to U.S. pressure in the 1980s to strengthen the yen, the result was a decade-long economic malaise. Even a 10% appreciation in the value of China's currency would lead to losses for many Chinese firms, he said.

Hubbard agreed that "there have been enormous benefits to the U.S. economy" from trade with China. But he wasn't buying the argument that the strong yen caused Japan's economic troubles in the 1990s--pinning the blame instead on "extremely poor" monetary policy and messed-up banks. And while admitting that "we don't really know the appropriate value" of the currency alternately and confusingly known as the yuan or renminbi (RMB), Hubbard rejected the idea that keeping it low helps the Chinese economy. "To the extent that there is an undervalued exchange rate, this is bad for China," he said.

That summation captures the mainstream opinion among economists and within the Bush Administration: China's export boom has been a good thing for the world economy, they say, but now it's in everybody's interest for China to reduce its trade surplus by boosting its consumer spending and letting its currency steadily rise. The U.S. would benefit because its exports would increase; China would benefit because a stronger currency would make its citizens wealthier, increase its global economic clout and keep inflation down.

This is an eminently reasonable view. It's probably even correct. But it's been losing ground lately to the extremes.

On one side is the U.S. Congress, full of people convinced that China's export machine is hurting their constituents. These lawmakers have had it with Treasury Secretary Henry Paulson's good-cop approach to China. A bill that would label the renminbi "fundamentally misaligned" and force the Treasury to do something about it is making its way through the Senate. Several different currency bills have been introduced in the House. The legislation for the most part is much less harsh than that proposed two years ago by Senators Chuck Schumer of New York and Lindsey Graham of South Carolina, which would have imposed a 27.5% tariff if China failed to revalue. But it is also much more likely to pass.

On the other side are the Chinese, who adopted a currency peg of about eight RMB to the dollar to stabilize their economy in 1994 and stuck to it even when there was great pressure to devalue after the Asian currency crises of 1997. Since 2005 the Chinese have allowed an 8% rise in the renminbi's value, but they are deeply suspicious of those who urge faster change. Never far from their minds is the sad example of Japan, which acquiesced to Washington and--many Asians are convinced--paid a terrible economic price. Adding to their suspicions is the fact that even currency experts have an awfully hard time agreeing on a value for the renminbi. "I find it ironic that the Congressmen are talking about 30% to 40% appreciation of the RMB, but the economists say they don't know how overvalued it is," Feng told me. "I think we should not politicize the issue."

Mr. Feng, meet Senator Schumer. A few days before, when I accosted Schumer outside a Senate committee room after a 20-to-1 vote for the currency bill, he argued that politicizing the issue was the only way to bring change. "I believe the reason the yuan has appreciated 8% is only because of the efforts of Senator Graham and myself," he said. "I don't believe the Chinese move out of a sense of comity and magnanimity." He's right that Paulson's attempts at gentle persuasion, including a late-July trip to Beijing, have delivered few results. But it's possible that the Chinese will stop moving entirely if they feel they're being pushed too hard.