On Wednesday the House of Representatives passed the Currency Reform for Fair Trade Act (H.R. 2378), a bill that would impose tariff penalties on Chinese goods unless the PRC allows the renminbi to appreciate against the dollar. In the lead-up to and in the wake of this event, there has been much media commentary on the escalating showdown between China and the U.S. over currency valuation. In yesterday's New York Times, Paul Krugman ("Taking on China") wrote that the bill is "a step in the right direction." Krugman notes that the undervaluation of the renminbi is causing trade imbalances that not only harm the U.S., but are retarding growth and economic recovery globally. On the same editorial page on Tuesday, Stephen Roach, a senior fellow at the Jackson Institute for Global Affairs at Yale ("Cultivating the Chinese Consumer"), warned that "forcing such a currency realignment would be a blunder of historic proportions." Roach argues that currency recalibration is not an effective escape from the current predicament, but that only a long-term reorientation of the Chinese economy toward increased consumer spending will redress the imbalances and set global markets back on the road to growth.
These and other well-informed commentators who have weighed in on either side of the issue make substantive arguments, but most American commentators have failed to account for a key dimension of the problem. Krugman and others are no doubt right, the Chinese Communist Party leadership is using monetary policy to keep the value of the renminbi artificially low, thus subsidizing exports to the U.S. and other foreign markets. But U.S. observers and leaders underestimate the power of the domestic Chinese political forces that drive CCP leaders to this choice.
Since the Tiananmen conflict of 1989 the CCP has labored under a persistent legitimacy deficit, one that it can only overcome through the maintenance of uninterrupted growth and full employment. An increasingly prosperous population has not forgotten its earlier aspirations for a more participatory government and a more liberal political culture. Unrest is only forstalled by the tacit understanding that inertia in political reform will be tolerated as long as economic prosperity is maintained. Any slackening of the rising tide of prosperity will reawaken the political grievances simmering below the surface of the social scene. This could lead to massive unrest, perhaps even to the overthrow of the CCP itself. In the face of such potential disaster, there is little with which the U.S. can threaten Chinese leaders. The displeasure of the U.S. President or Congress holds little terror next to the rising anger of the great mass of China's citizens.
If the tariffs imposed by the House ever do go into effect, it will of course create just the sort of economic pain Beijing hopes to avoid at all cost, but the CCP leadership will have the recourse of portraying that misfortune to their own people as the result of U.S. economic aggression. If a drop in growth and employment must come, having it come because of Washington rather than Beijing would, from the perspective of the CCP, definitely be the lesser of two evils. Given the "caged and cornered" outlook of CCP leaders, Beijing is most likely to keep calling Washington's bluff until the brink has been reached and passed, and a full-blown trade war gets underway.
Though such circumstances argue against the wisdom of the House's recent action, policies like that proposed by Stephen Roach are also problematic, for similar reasons. Any measures to increase consumer spending in China would, like a drop in employment, re-open the issue of political reform. As consumption increases so does official corruption, a problem which is already at epic levels throughout the PRC. Moreover, as people consume they increasingly come to think of themselves as property owners with a greater stake in the system at large. The more I buy, the more I have to lose, and the more means I will want to protect what I have. It is rare to find a society in which a citizen who is a consumer is not also a voter, or at least wants to be. Finally, increased consumption in China would add to the already dire ecological crisis she faces. Anyone who has seen the state of public sanitation in many areas of China given current levels of consumption will understand that a major overhaul of the political system will be necessary to mitigate the damage of an increase. To create the conditions that would foster local governance capable of handling such growth, power must devolve from Beijing onto the provinces, localities, and citizens, otherwise local authorities could not be held accountable for the tasks that must be undertaken.
A shift to a more consumer-driven economy in China is thus not possible in the absence of a simultaneous process of political decentralization and democratization, a fact of which the CCP leadership is aware. This is, in fact, one of the latent motivations for Beijing's monetary policy. Besides fueling exports, undervaluing the renminbi has the serendipitous effect of suppressing consumption, obviating the need for the kinds of political reforms that would otherwise be necessary in the face of rising prosperity.
What do all of these facts mean from the perspective of U.S. policymakers? Unfortunately, given the power of the inertial forces driving Beijing's currency policy, the U.S. possesses virtually no effective levers of persuasion. The trade imbalances created by the undervaluation of the renminbi are a real problem for the U.S., but it is unrealistic for American leaders to expect that they may be resolved either diplomatically or through punitive legislation. The best measures that can be taken in the face of this problem are changes in U.S. domestic economic policy. Tax incentives and public investments in industries that can compete in Chinese markets despite Beijing's efforts at currency manipulation are the most effective tools at the disposal of U.S. leaders, and have the added appeal of increasing employment and prosperity at home in the short term. Beyond this, everyone's best hope is that leaders and citizens in China will undertake the kind of political reforms that will alleviate the dysfunctional conditions fostering today's trade imbalances.