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China’s Currency Manipulation: A Policy Debate

Confront China Now

In 2001, under the banner of a “policy of engagement” dating back to the Nixon era, China joined the World Trade Organization with the strong support of a Democratic president and a Republican-controlled Congress. Before the ink was dry on this free-trade agreement, Beijing began flooding American markets with illegally subsidized exports while the big multinational companies that had lobbied heavily for the agreement rapidly accelerated the off-shoring of American factories and jobs to China.

Today, the United States owes more than three trillion dollars to the world’s largest communist nation; more than fifty thousand American factories have disappeared; worker and human rights abuses are endemic in a country that is also now the most polluted on the planet; and the People’s Liberation Army is engaging in the most rapid military buildup of a totalitarian regime since the 1930s.

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This was not how it was supposed to turn out when President Clinton was selling China’s entry into the World Trade Organization to the American people. Indeed, he promised the brightest of futures, in which “for the first time, China will agree to play by the same open trading rules we do,” and “our companies will be able to sell and distribute products in China made by workers here in America.” The optimism was bipartisan. Texas Republican and then House Majority Whip Tom Delay, celebrating the congressional vote that paved the way for China’s WTO entry, said: “We have waged an intense battle in support of an important principle, and that is freedom. And the people of China and the citizens of the United States will benefit enormously. It’s a confrontation of worldviews that we will win, and I’m looking forward to the future.”

 

So just what has America’s future looked like since China joined the WTO in 2001? Richard McCormack, the editor and publisher of Manufacturing & Technology News, gets to the heart of the mercantilist matter by observing, “For China to sell something at one tenth the price of what it would cost in the United States to produce, they are cheating monumentally, in a major, massive sort of way.” According to Dan Slane, head of the US-China Economic and Security Review Commission, “We are in a trade war and stealing, lying, and cheating on the part of the Chinese are all part of it.” As a businessman, Slane has personal experience. He had a manufacturing facility in Bowling Green, Kentucky, selling plywood to US furniture manufacturers when, in 2002, all of his competitors began moving to China. Slane joined the exodus, opened up three factories there, and quickly started delivering to his US customers at fifty percent less than he could in Bowling Green. Looking back on his success, Slane explains: “[China’s] manipulating the currency was a huge help because it kept our prices down. I had no environmental issues; and the most important thing was that I could sell my product at cost and every month, the Chinese government would send me a check for seventeen percent of my exports, and that was my net margin and profit.”

Slane’s experience is fully consistent with a truth so widely ignored that it seems almost to be a conspiracy: The most potent driver of China’s competitive edge is not cheap labor, as is commonly believed, but rather a potent set of illegal trade practices that Chinese officials promised to abandon as a condition of joining the WTO.

China’s complex web of illegal subsidies, for example, ranges from subsidized land, capital, and utilities to the kind of tax breaks mentioned by Slane, which allowed him to sell into the American market at cost and still make a hefty profit. As Thomas Danjzcek, president of the Steel Manufacturers Association, notes: “It makes no sense that China, which produces forty-five percent of the steel in the world, has high manufacturing costs yet sells steel at the lowest cost in the world and is growing at a rate of seven or eight percent. This growth is all due to state subsidies. At the end of the day, it will certainly result in more unemployment in the US and to the advantage of China. We’re chumps!”

Perhaps the most destructive, and least understood, of China’s illegal trade practices is currency manipulation. Most economists estimate the Chinese yuan is grossly undervalued by anywhere from twenty-five to forty percent—and only propagandists like the China Daily and hired guns for China profiteers like Goldman Sachs and Morgan Stanley claim otherwise.

China manipulates its currency by pegging the value of the yuan primarily to the US dollar. To maintain that peg in the face of massive trade surpluses with the US, China must recycle hundreds of billions of dollars of that surplus back into the US every year. China does so primarily by buying US bonds—but increasingly by also scooping up US real estate, companies, and other assets.

One obvious result is a US debt to China, now approaching three trillion dollars. This debt has exposed the US to significant political pressure. China’s fixed peg also makes it impossible for the US to ever balance its trade through the normal kind of currency adjustments that are the hallmark of mutually beneficial free and fair trade. Patrick Mulloy, of the US-China Commission, observes: “It’s like having a tariff on goods coming from the United States of forty or fifty percent by the amount that they’re underpricing their currency. It also gives their exports to the United States a subsidy of forty or fifty percent to capture our market and knock out domestic industries that might be competing with them.”

Still a third major weapon of job destruction wielded by China’s largely state-owned enterprises is that of blatant counterfeiting and piracy. As economist Ian Fletcher explains, it’s not just about pirating Hollywood movies anymore: “What’s more important is the theft of the blueprints for high technologies. I hear all the time about American companies who find themselves competing in the marketplace with a Chinese product, and they take it apart, and they find themselves looking in the mirror because the Chinese have just stolen the plans of their own product.”

Of course, when a Chinese enterprise steals intellectual property that an American rival had to pay significant R&D monies to discover and develop, that Chinese enterprise gains an additional production cost edge—as much as fifteen to thirty percent in R&D-intensive industries like automobiles and pharmaceuticals.

Rounding out China’s mercantilist advantages are some of the laxest environmental and worker health and safety standards in the world. “If a company like Bao Steel in China is allowed to dump pollution into the Yangtze River when, say, a US steel company is not allowed to do the same in the Ohio River,” says Fletcher, “that’s going to be a source of competitive advantage for the Chinese because pollution control costs money.”

China is also a country where, as Congressman Chris Smith, a New Jersey Republican, laments, “You go to prison if you try to form a labor union.” AFL-CIO President Richard Trumka echoes this complaint: “They don’t comply with their own child labor laws, prison labor laws, health and safety laws, minimum wage laws.” Within this context, says former Canadian MP and Nobel Peace Prize nominee David Kilgour, every American consumer should be asking this question on their way to the checkout line: “How can Walmart, or anyone else in the United States, allow production facilities in China to sell garments, chopsticks, Christmas decorations that are made in forced labor camps?”

 

China’s unfair trade practices have indeed taken a very heavy toll on the American economy. Consider that for the second half of the twentieth century, the US gross domestic product grew at a healthy rate of about 3.5 percent annually. Since China joined the WTO in 2001, however, that rate has fallen to an average of only 1.6 percent. While the loss of almost two percentage points of GDP growth a year may not seem like much, it translates into a failure to create two million jobs a year and cumulatively more than twenty million jobs lost to slow growth since 2001. Not coincidentally, that’s almost the exact number of jobs America now needs to get its people fully back to work.

These startling statistics raise two questions: Why do our political leaders in the United States put up with China’s unfair trade practices; and why haven’t our politicians realized, as businessman and philanthropist Leo Hindery has frequently observed, that “the best jobs program” is not more fiscal stimulus or easy money from the Federal Reserve but rather “trade reform with China.”

At least one reason is that America’s biggest multinational companies, like Apple, Boeing, Caterpillar, and GE, are now benefitting from off-shoring their manufacturing to China. As think tank analyst Alan Tonelson notes: “We can never forget that when China manipulates currency, when China provides illegal subsidies of all sorts—for manufacturing, for the act of exporting itself—these US-owned companies benefit. They like the status quo, they want to protect it, and they have paid a lot of [lobbying] money for it.”

As bad as America’s economic engagement with China has been for American workers, it’s been even worse for China’s huddled masses. As the economist Ian Fletcher has pointed out, “Economic growth in China has not led to its becoming more democratic. It has led to a more sophisticated, better-financed form of authoritarianism.” Manufacturing & Technology News editor Richard McCormack adds that China is “less free today than it was when they entered the WTO.” And yet Secretary of State Hillary Clinton remains adamant in her posture that human rights and trade with China should not be linked.

What is to be done in the face of the severe consequences of America’s economic engagement with China? Perhaps we should take a page out of Ronald Reagan’s playbook; he believed that even though we might want to “trust” the Soviet Union to abide by treaties we should also “verify.” By analogy, the White House and Congress may want to continue to engage Beijing on economic issues, but for a number of reasons—including China’s blatantly unfair trade practices, its horrific human rights abuses, and its aggressive military buildup that increasingly threatens our friends and allies in the Pacific—a confrontation is long overdue.

Peter Navarro is a professor at the Paul Merage School of Business, University of California-Irvine. This article is based on interviews he conducted for his documentary film, Death by China, which premiered in August. His website is www.deathbychina.com.

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