TARIFFS CAN PERSUADE BEIJING TO FREE THE RENMINBI 7 THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( VERY HIGHLY RECOMMENDED READING )

Tariffs can persuade Beijing to free the renminbi

By Robert Aliber

Published: December 7 2009 20:43

International payments arrangements are at an impasse much as they were in the summer of 1971, when there was widespread recognition that trade imbalances were far too large.

Then, the values of the Japanese yen, the French franc and the British pound were frozen to the US dollar; no country wanted to take the initiative to realign currencies. Today the problem is the unsustainable US-China trade imbalance. China’s exports of manufactured goods have increased at a rapid rate, but the adjustments that would have led to comparable increases in imports have not occurred because China refuses to budge in allowing the value of the renminbi to increase.

Beijing’s unprecedented accumulation of $2,000bn (€1,350bn, £1,225bn) of US dollar securities is the product of its “beggar-thy-neighbour” policy in importing jobs. The undervaluation of the renminbi has the same impact as an import tariff of 50 or 60 per cent.

A principal motive for the cheap renminbi policy is Beijing’s concern that domestic unemployment will increase if the currency strengthens. Moreover, the low value for the currency facilitates China’s move up the technological ladder, since imports of high-technology products from the US, Japan, Germany and other industrial countries are stalled while domestic production of similar goods is increased.

China’s large holdings of US securities have enhanced its political clout and given it the standing to comment on US interest rates and the US fiscal deficit. And as long as China’s trading partners are focused on the huge trade surplus, their other demands on Beijing are modest.

Americans have been patient – too patient – in accepting the loss of several million US manufacturing jobs because of China’s determined pursuit of mindless mercantilist policies. The absurdity of the current situation is that China’s currency protectionism has more of an impact on American manufacturing employment than US fiscal policy.

The US can help China make the necessary adjustments toward a reduction in imbalances by adopting a uniform tariff of 10 per cent on all Chinese imports, based on their values when they enter the US. Six months after the establishment of this tariff, the rate would increase by one percentage point a month until the Chinese trade surplus with the US declines to $5bn a month.

The precedent is clear. In August 1971 the US adopted a 10 per cent tariff on dutiable imports to induce Japan and several European countries to allow their currencies to float. The measure quickly accomplished its goal – the European countries stopped pegging their currencies immediately and the Japanese allowed the yen to float a week later. The tariff was eliminated after a few months.

Because many Chinese exports contain large amounts of embedded imports, the 10 per cent import tariff in effect is a tax of more than 30 per cent on Chinese value added. With electronics and other high-tech exports, where the import content may be 70 or 80 per cent of their value, the 10 per cent tariff might be equivalent to a tax of 60 or 80 per cent on Chinese content.

It should not take long for the Chinese to learn that they are much more dependent on access to the US market than Americans are dependent on Chinese goods. Virtually all of the goods that the US imports from China could be sourced at home or in Indonesia, the Philippines or South Korea. China would find it difficult to find other foreign markets for the goods that it no longer sold in the US.

The Chinese might huff and puff about US protectionism and threaten that they will no longer finance the US trade deficit – but that chatter would be hollow because the single most important cause of that deficit is Chinese purchases of US securities. Such an initiative by the Obama administration would be much more significant as a jobs-creation measure than anything else it could adopt.

The Chinese authorities can hide behind the smokescreen of American protectionism to undertake the adjustments that some in the People’s Bank of China must already recognise is inevitable. The experience of the early 1970s suggests that once the logjam has been broken and imbalances reduced, the Americans and the Chinese can focus on North Korea, Iran and other contentious issues.

The writer is professor emeritus of international economics and finance at the University of Chicago

Copyright The Financial Times Limited 2009