Dollar Diplomacy

GWEN IFILL:

Treasury Secretary John Snow traveled to China this week with a strong message from the U.S. government. China's weak currency is costing America jobs, but Chinese officials don't see it the same way and therein lies the crux of an emerging debate between the two nations.

The Chinese currency, called the Yuan, has been pegged to the value of the U.S. dollar since 1994. But some argue China's currency has been under valued, making Chinese goods cheaper and American goods more expensive. U.S. manufacturers claim the exports they send to China cost 25 to 40 percent more than they should, and they argue that difference may be contributing to the significant job loss in the U.S. manufacturing sector.

China says any change now would threaten its economic stability. Here to explain the dilemma: Linda Lim, a professor of international business at the University of Michigan, and C. Fred Bergsten, the director of the Institute for International Economics.

GWEN IFILL:

Mr. Bergsten, we ordinary Americans can be forgiven for wanting to understand, if we're not members of National Association of Manufacturers why it matters what China's currency value is. Can you explain it for us?

C. FRED BERGSTEN:

Yeah, the problem is that the U.S. is running an overall trade deficit of about $600 billion. That is a big drag on our economy because it means a lot of the demand for the products and services we generate at home are met by foreign suppliers, Chinese, Japanese and others creating jobs there instead of here at home.

Likewise, there's a risk with the trade deficit of that magnitude that the exchange rate of the dollar may come crashing down one of these days like it has three times in the last 30 years. That raises big financial instabilities and risks.

The better course, therefore, is to get a modest orderly steady correction of the exchange rate of the dollar. The dollar has, in fact, come down about 30 percent against the Euro and therefore the European countries over the last couple of years, but it hasn't budged at all against China.

China is the biggest single share of our huge trade deficit, but China pegs its currency to the dollar. So when the dollar comes down against the Europeans and others, the Chinese currency comes down with it, actually increasing their price competitiveness, strengthening their trade position, making them an even tougher competitor.

Our calculation is that the Chinese currency undervalued by about 20 to 25 percent. If they would raise it by that amount, thereby permitting other Asian currencies also to go up at least part way, we would probably get something like a $50 billion reduction in our trade deficit.

That would add something like 500,000 manufacturing jobs to the U.S. economy. It wouldn't solve our unemployment problem, it wouldn't reverse the decline in manufacturing employment but it would be a substantial benefit to the economy.

So on all counts, domestic job creation, reducing the risk of big trade deficit and reducing the risk of protectionist trade pressures against China there's a strong case for having that kind of currency change, and I believe it's in China's interest to do it as well.

GWEN IFILL:

Well, Linda Lim, let's talk about what is in China's interest. If as Fred Bergsten explained, there are all these reasons why the Chinese should allow their currency to float instead of being fixed so closely to the U.S. dollar Why not do that?

LINDA LIM:

Well, China has two main reasons why it does not want to revalue or float its currency at this time. The first reason is that it will make its exports more expensive. This could threaten the jobs of millions of workers in China at a time when unemployment is already high and increasing for other reasons, specifically the decline in the state owned sector, the reform of the state owned sector and also the fall in trade barriers due to China's entry to the WTO. So, that's the first reason: The threat of job loss and social instability that could result in China.

The second reason is China is concerned about the effect of opening its markets to movements of money in and out: the free movement of capital in and out of China and this could destabilize its already fragile domestic financial system. The Chinese have said repeatedly that they are committed to liberalizing their currency but only when they are ready, when the financial system is sound enough. They are undertaking the reforms now. It will take years.

GWEN IFILL:

Which industries are we talking about Mr. Bergsten? Are we talking about steel, are we talking about textiles? Who are the American companies in particular and the Chinese companies I guess on the other side, who are most — who have the most to gain or lose in this?

C. FRED BERGSTEN:

Well, we are talking about steel and textiles and other traditional U.S. industries that compete with imports. But we're also talking about a whole range of high tech and capital equipment sectors. The Chinese are increasingly competitive at everything from laptops to computer software so the competition on the import side is across the board.

On the other side of equation U.S. exporters of aircraft, capital equipment, high tech products from here are being disadvantaged by the expensive dollar, the low exchange rate for the Chinese currency in going into China.

Incidentally, I might say I agree with the comment that the Chinese should go slow in opening up their markets to international capital flows. That would risk instability. I agree with that point.

Therefore I think it's a mistake to suggest to the Chinese that the way to deal with the problem is to float their currency; they can't float their currency.

GWEN IFILL:

What is the alternative?

C. FRED BERGSTEN:

The alternative is to make a one step increase in the value of currency. It's now worth 8.3 Chinese Yuan to the dollar. They should raise that price in one step to 6 and half or 7 Yuan to the dollar. That would be a revaluation of 20-25 percent — they could keep the fixed exchange rate — not subject themselves to the vagaries of the capital market but put the price of their currency at a level that would more accurately reflect their economy.

I asked the minister of finance in China when I met with him last when they might move to free capital movements and therefore flow to the currency. He kind of smiled and said well, some people talk about the time of the Olympics by which he means the Beijing Olympics in 2008. That's too long to wait.

GWEN IFILL:

Linda Lim, do you think that might be a middle ground there, a step by step relaxation of the valuation?

LINDA LIM:

Well, in theory, yes, but the Chinese concern is that a step by step revaluation would not assure the markets that this was just a one-time only movement. They have concerns that if they revalue by one step, then speculators including their own citizens have capital outside of the country or inside the country to move around, their own citizens and outsiders might speculate that the currency might be revalued again because to the extent that the U.S. dollar seems to continue to fall, the Chinese currency will keep being — even if it's re-pegged, it will be weakened to the extent that the U.S. dollar weakens as well.

GWEN IFILL:

The U.S. has been talking tough in this — Treasury Secretary Snow in going to Beijing was trying to talk tough about this saying you gotta to do this, you have to help us out. This is a shift for this administration. They weren't pushing so hard before. Do we smell politics afoot here?

C. FRED BERGSTEN:

Well, politics is clearly driving the administration. But unless you heard something I didn't hear I'm not sure if Secretary Snow actually talked very tough. He suggested the Chinese ought to move, he suggested it was in their interest to do it, he talked about the long term goal of moving to free capital movements and floating currency.

GWEN IFILL:

So if he wasn't talking tough, what was he doing?

C. FRED BERGSTEN:

He was trying gently prod them to move but without jeopardizing the overall U.S./China relation. Overall foreign policy comes into play in a big way here. The U.S. needs China on North Korea. It needs China on antiterrorism. Relations with China are pretty good, pretty delicate but important these days. So I think secretary was trying to get as far as he could with gentle nudging. But I wouldn't say this was tough talk, nothing like the U.S. has done with Japan and other countries in the past.

GWEN IFILL:

Linda Lam, what did you hear watching the exchange, such as it was, between John Snow and his Chinese counterpart?

LINDA LIM:

Well, I can see the U.S. point of view. It's a political situation in the U.S. But China cannot be blamed for the unemployment in the U.S. not even in the manufacturing sector. After all, China accounts for less than 10 percent of U.S. imports and less than 2 percent of the U.S. Economy What's going on is much bigger than simply a 10, 15, 25 percent, who knows overvaluation of the Chinese currency.

And to some extent it's quite possible that focusing on China deflects attention from other more fundamental domestic reasons why unemployment is so high. So, from the Chinese point of view I can see why they don't feel that they have to budge. It's not their fault. It's not their problem. Why should they risk a lot of possible changes at home that are negative for them for something which if they did may not even cure the U.S. problem of unemployment.

GWEN IFILL:

Linda Lim, Fred Bergsten, thank you very much for helping us out.

C. FRED BERGSTEN:

Good to talk to you.