Friday Rant -- Should we Rethink Free Trade?
The topic of conversation on date night with my wife last weekend turned to an area she's been thinking quite a bit about recently. And that's free trade. Lisa had just come back from some time on the road that week visiting with a couple of large organizations in the steel and metals industries, one of which was a company with a strong anti-free trade stance (or at least a strong anti-China stance). Now, to know Lisa's position on trade and politics is to know mine -- potentially even in the extreme.
Lisa is about as free market, free trade as they come. She can't stand protectionist kvetching in the least. But she came away from one of her meetings with a general manager at a steel company at least partially convinced that the steel lobby had a point regarding China. Was she softening her stance on the issue? Not exactly, but she thought the steel lobby -- and the general protectionist lobby -- could make a far better argument in their favor if they tried staying away from rhetoric and moved toward grounding their arguments in facts.
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At the heart of the argument against free trade with China, these organizations argue, is the country's currency manipulation that led to the original trade surplus in the first place. Directly manipulating the RMB downward made China's exports less expensive than in the past both for a range of raw materials, and as we all know in the global sourcing world, finished products as well. Now, it's possible to counter this argument in quite a strong capacity. After all, even though the US does not manipulate its currency in the same manner, we have a long record of providing agriculture and other subsidies to support certain favored industries.
But the metals industry lobby potentially has a strong trump card to use against China. Taking their basic premise on face value, their primary argument against free trade is that free trade never existed in the first place given the Chinese government's initial move to devalue the currency. Moreover, given recent government incentives to maintain base metals and other production (e.g., buying-up and inventorying capacity) and the not-so-fine line between private sector companies and government investment -- as my friend, Brian Sommer, likes to say, "they don't call them the Red Chips for nothing" -- it becomes pretty clear that China does not exactly level the global playing field through its economic policy.
Without question, I'm sure China could point to a similar number of US and European policies that actively protect domestic producers in the countries that their suppliers are trying to sell into. But the constant meddling and micro-management of the Chinese economy is certainly without par in the modern era (the same can be said for its mercantilist policies in Africa and other regions where it attempts to get its hands on raw materials).
I initially wrote this column to see if I could take a contrarian stance on my usual free-trade rants. But the more I thought about it, the more I began to understand the argument that posits the need to implement some protectionist measures to level the free-trade playing field. I'm not sure if I agree with all of them, but I can at least see their point. What do you think? Especially you free-traders out there in the audience -- should we implement policies that may appear protectionist but are really the only possible way of righting the free trade ship? Or should we risk heading into the lifeboats and back to shore, leaving the sinking barge behind, regrouping for another trade mission in the future once the current seas calm down.
- Jason Busch
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How can you tell when a currency is misvalued? One approach is to compare the current exchange rate to the Purchasing Power Parity (PPP) rate. The CIA publishes every country's GDP converted to dollars at both the actual and PPP rates.
(The PPP rate is the rate at which a market basket of products would cost the same in both countries.)
Based on this, the CIA says the PPP rate for the Chinese yuan in 2008 was 3.71 per dollar compared to a real rate of 6.85 on 1/1/09. That's undervalued by 46% (of the PPP rate.) But China's not alone. The Indian rupee is 62% undervalued. The Malaysian ringgit 45%, the Thai baht 51%. Even the currencies of wealthy countries such as Korea and Singapore are about 35% undervalued. Why is China being singled out?
Well, it's big. And it's successful. And like most developing countries, it is weak in environmental controls. But that's a topic for a different rant.
China is taking steps toward making their currency exportable. Once an open market will help it find a more realistic value. But it's never going to be perfect. For example, the US dollar is undervalued by about 35-40% against the euro based on PPP.
On the one hand, PPP comparisons of currency may be entirely appropriate. I actually don't even know. But what I do know is that when I look at the history of China RMB/USD exchange rates, it's very difficult for me to walk away with the conclusion that currencies aren't manipulated. Here is 1990 - Present http://www.federalreserve.gov/releases/H10/hist/da... and this one is from 1981 - 1990 http://www.federalreserve.gov/releases/H10/hist/da... I would love it if someone can present to me an argument that says this is not currency manipulation!
Now to be sure, I'm conflicted. I'm writing a piece now on the tinplate market for MetalMiner and I can tell you that US buyers pay more for tinplate than any other country on earth! And that's thanks to Big Steel's anti-dumping cases and and a sympathetic DOC. You will also be happy to know that China isn't even involved in this one! So for sure, when power is given to the hands of a few, true markets are not possible. I'm not anti-free trade (yet). But I am diving into some of the detail because there are several things that I'm struggling with re: the case for free trade:
1. Currency manipulation
2. Our current account deficit
3. The deficit we carry with most of our major trading partners including those we have free trade agreements with (e.g. Mexico, Japan, Canada, Europe and of course China)
4. Loss of manufacturing in the US to China
We are doing some digging on all of the above especially in terms of steel and the broader metals markets. If anyone has compelling data to share, we're all ears!
In mid 2005, the exchange rate started changing smoothly until it got to 6.85 in October 2008. They repegged it there and it has been there ever since.
They even kept it there during the general Asian currency collapse of 1998. The won, baht, ringgit, Taiwan dollar all lost about 50 percent of their value. China held their peg and hence lost competitiveness against all their neighbors. I think that was pretty statesmanlike.
Wikipedia has a fairly good article on pegging titled "Fixed exchange rate." Is it manipulation? I haven't heard pegging called manipulation except with reference to China
One reason for China holding a peg is that a large part of high-value Chinese exports (computers, telephones, etc.) is not Chinese content. A few years ago I was seeing numbers like 45-50%. There's a lot of importing into China to support their exports. Another reason is that pegging helps prevent inflation.
Are you involved in exporting raw materials from China? The supplier's cost doesn't have much to do with those prices because they are set by market conditions.
As far as the US difficulties, those are all true. The trend doesn't look good as far as the US being able to maintain a higher standard of living than other countries. In order to do that a country has to do things other countries can't do, or do the same things more efficiently and cheaply. Protectionist steps are really futile. It's all about education and efficiency.
The dollars that China accumulates in these transactions are then invested in United States Treasury securities.
So when we complain about the undervalued yuan (currency manipulation), our message to the Chinese boils down to this: Stop lending us money.
If China took us seriously, long-term interest rates would rise. As the United States embarks on a path of unusually large budget deficits (Bailout and Healthcare), the nation’s chief financial officer should pause and think carefully before turning up the heat on one of its biggest creditors.
So should we really re-think free trade?
Geoff, As for China acting as our "bank", I'd be more than happy for us to wean ourselves from cheap imports and hold some of those dollars. The bail-outs make me sick. The fact remains, we ought to live debt free, just like our grandparents did. Just as it's not a right to own a home, it's not a right to own a flat screen TV. Higher domestic prices for everything would cure some of our rampant consumerism. I'd take the lower GDP and increased savings in exchange for trade deficits and constant borrowing.
Here's a post on Warren Buffett's idea on how to get rid of the trade deficit:
http://agmetalminer.com/2009/04/08/warren-buffett-...
Keep up the comments. I'm still waffling.