US dabbles in trade protectionism, China wallows

President Obama and Europe share a problem: both are being snubbed by China on trade. The President's recent trip to the PRC included accusations by the Chinese of US protectionism. This statement was the first attack of its kind by Beijing, and it came after American decisions to raise trade barriers against Chinese goods.

During the EU-PRC summit recently, Chinese Premier Wen then went on an outrageous offensive, claiming that the yuan's peg to the dollar helps the world's economy, attacking critics as trade protectionists themselves, and accusing them of trying to restrict Chinese development.

The EU's reaction to Wen's tirade was to cancel their final press conference. This response was at least an improvement over President Obama's choice not to respond. The lack of a US trade policy is truly a handicap. But even if he cannot bring himself to enunciate a full policy, the President should make it clear that China should not be lecturing anyone on free trade. The solutions in trade may be difficult to see, but the problem is manifest, and the bulk of it resides squarely on the western side of the Pacific.

Why Wen is wrong

In almost all of its statements, the PRC insists that it is not seeking a trade surplus. The facts, however, indicate otherwise. From 2005 to 2008, China reported a cumulative trade surplus of $837 billion. Its partners report an even larger imbalance.

Wen's aggression on behalf of Chinese policy is equally at odds with reality. Those huge surpluses are one source of global imbalances thought to be a major factor in the financial crisis. The surpluses enter Chinese GDP as a positive, boosting the PRC's growth. They enter the rest of the world's GDP as a negative, detracting from growth. The yuan peg currently makes Chinese exports cheaper than they otherwise would be and their imports more expensive. This widens the trade imbalance and thus immediately reduces the rest of the world's GDP.

Wen is technically correct that national critics of China are protectionist, since all countries engage in protectionism. And trade barriers have unfortunately risen with the global crisis. However, the PRC is far more protectionist than its major partners, heavily subsidising domestic firms to compete against imports and in overseas markets.

Perhaps most disingenuous is the accusation that China's trade partners, which have been utterly indispensable to its economic development, are plotting against the PRC. The Communist Party has been trotting out versions of this accusation - that the US is trying to contain China - when useful for the past 15 years. It has been cited most recently with regard to climate change. In fact, Chinese trade practices harm China's partners, so the PRC can be accused of interfering with India's rise, Vietnam's rise, and the ascent of other trade partners.

Two crises

Exchange rates in particular are a political focal point, and the yuan's peg to the dollar has been vital in Asia-Pacific trade for over a decade. In 1997-1998, East Asia suffered a financial crisis, and the region was immensely relieved when China held to the peg, eschewing devaluation. It won a decade's worth of gratitude and praise, particularly from its neighbors. But Beijing kept the yuan fixed entirely for its own reasons.

A wide trading band for the yuan was out of the question in 1997, as the exchange rate was seen as crucial in manipulating the economy. With regards to devaluation, in 1997 the PRC was still scarred by high inflation and terrified of capital flight overwhelming its weak financial system. Devaluation was seen more to threaten internal stability than to promise benefits for exporters.

Fast forward to 2008-2009, and Asia is again suffering a financial crisis. China again clutches the peg, on the basis of the same calculations as before. Beijing plainly is not ready to float the yuan - the peg was tightened before Lehman Brothers collapsed and the financial shock hit. While there are advantages to revaluation, the threat of further job losses among exporters was determined to be too great.

This time, Chinese policy has hurt its neighbours and partners around the world. For example, the yuan has fallen 17 per cent against the euro in seven months. For Wen to label all the victims of Chinese currency policy as "protectionist" and accuse them of restricting China's development is ridiculous. The global reaction is merely the natural one to an undervalued currency, just as the praise 12 years ago was a natural reaction to a (briefly) overvalued currency.

Irresponsible stakeholder

So what changed between 1998 and 2008? Not the Communist Party's overwhelming desire for control and apparent stability - which drove the decision to hold firm to the peg a decade ago and is driving the same decision today.