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There's a dangerous fantasy taking hold in Washington: The U.S. can force China to strengthen the yuan. Since the beginning of September the Chinese currency has appreciated about 1.8 percent against the dollar; China may be allowing it to drift higher to stave off American retaliation. Bills pending in the House and Senate would push the Administration to penalize Beijing through tariffs if it doesn't let the yuan rise further. "At a time when the U.S. economy is trying to pick itself up off the ground, China's currency manipulation is like a boot to the throat of our recovery," Senator Charles E. Schumer, a New York Democrat and sponsor of one of the bills, said at a congressional hearing this month.
Washington's emphasis on the yuan's value is understandable. It's a conspicuous, trackable indicator of the bilateral relationship. A stronger yuan would shrink the trade imbalance by making American goods more competitive and would help China by suppressing domestic inflation.
Ultimately, though, trying to muscle China into revaluing the yuan would be a mistake. If the U.S. punishes China in ways that aren't allowed by the World Trade Organization, it could risk a trade war, lose the support of other nations, and damage the free-trade system it has worked for decades to develop. By putting so much energy into pushing the yuan upward, the U.S. has less to spend on other critical issues, such as China's discrimination against high-tech imports. And higher inflation in China is already pushing up the yuan's inflation-adjusted value, which is what matters for trade flows. China's global current-account surplus is on track to fall from 10.7 percent of gross domestic product in 2007 to just 2.7 percent in 2011, Deutsche Bank (DB) economists estimated on Sept. 22. "The narrow focus on the currency is misguided," says Joanne L. Thornton, an analyst at Concept Capital's Washington Research Group. "You have to look at the broad landscape of issues."
China has played it smart. Its authorities have been slow to act on U.S. trade complaints, but they have mostly avoided clear-cut violations of WTO rules. If the U.S. retaliates in a way that's contrary to those rules, it could find itself identified as the bad guy.
One House bill that might run afoul of the WTO was introduced by Representative Tim Ryan, an Ohio Democrat, and Tim Murphy, a Pennsylvania Republican. (It has 150 co-sponsors—proof that everyone sees a political win in bashing China in an election year.) The Ryan-Murphy bill would amend the Tariff Act of 1930 to require the Administration to consider exchange rates when investigating allegations of subsidies or dumping. A currency would be considered undervalued if it was as little as 5 percent below its estimated fair value—a hair trigger that would be hard to defend given there's no precise way to calculate the "correct" value of currencies. Schumer's bill would give the Administration more discretion on whether to prosecute a case, but it's still based on the untested theory that currency undervaluation is a legitimate target for countermeasures. Ira Shapiro, a trade lawyer at Greenberg Traurig who was general counsel to the U.S. Trade Representative under President Bill Clinton, testified before Congress on Sept. 15 that he was "very doubtful" the WTO would allow such an approach. (On Sept. 22 the bill was tweaked in ways its sponsors say will better pass muster at the WTO.)
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