A bipartisan bill is being advanced in U.S. Congress to label five East Asian countries as currency manipulators. These countries are: China, Hong Kong, Malaysia, Taiwan and Singapore. “Israel” is well known on the website of New York Times as a currency manipulator but Congress is not including it in the above group.  On the other hand, China is being singled out.  The other four countries seem to keep their currencies undervalued in order to compete with Chin's export in the same markets. A currency manipulator tries to steal economic growth from other nations through trade by keeping its currency undervalued or cheap. Currency manipulation leads to currency and trade wars and protectionism, both could plunge the world economy into a new recession.

Congress is seeking to impose a currency misalignment fee as a countervailing duty on the manipulators’ exports to the United States. This is equivalent to a forced appreciation of the manipulator’s currency. Once things are taken by the U.S. Congress, it means the issue is being politicized and in this case it is taken out of the realm of the World Trade Organization (WTO). Congress wants to play the “good cop” and the White House to play the “bad Cop”. This means the situation may get “ugly” between the United States and China.

There are people in the United States who are part of China’s bashing and are pushing Congress to take measures against China. The bashers are motivated by political and economic reasons to act against China. On the economic front, the United States has a large trade and current account deficit  with China in absolute terms, amounting to $229 billion and $420 billion, respectively,  in 2009, constituting 1.5 percent and  2.8 percent of the U.S. $15 trillion GDP.  The bashers want to reduce these deficits.  They claim that this trade gap is taking jobs from the American people. Some senators contend that each annual $100 billion dollar in trade deficit with China takes 700,000 jobs from the American economy annually. Senator Charles Schumer (D-NY) argues that the trade deficit with China had cost the United States 2.8 million jobs over the period 2001-2008.  C. Fred Bergsten of Peterson Institute for International Economics estimates that  if the renminbi is allowed to appreciate by 40 percent,  it would lead to a decline in  the U.S. trade deficit by $100 billion annually. Others are also concerned that China is holding two trillion dollars worth of American securities, of which $889 billion in government Treasury securities, making  the United States vulnerable. They want China to spend more and save less domestically.

There are also those in Congress who hold political grudges against China. They are concerned that China is working steadily on becoming a fully fledged superpower. They see China as a hurdle in imposing sections against Iran. There are those who support Taiwan and stand against China’s efforts of adding that island to the mainland. There are those who accuse China of human rights violations and want more freedom in China.

Against all of the above, there are many people who call for structural changes in the United States and advocate free trade. They ask for equity between U.S. and China's corporate tax rates, which is 40 percent in the U.S., compared to 25 percent in China which would be 12 percent  if adjusted for subsidy.  They see a reduction in the U.S. corporate tax rate as a source of insourcing that would bring jobs back to the United States. They view the currency misalignment fee as a hurdle to free movement of goods and services. People with these views consider China’s relatively inexpensive exports as a boon to the U.S. consumers at a time when the U.S. is drowned in a Great Recession. Those who shop at Wal-Mart, Target and JCPenney see inexpensive Chinese goods as a source of enhancing social welfare. There are others who view China’s holding of U.S. securities as a recycling of American dollars to America and a reason for low interest rates. There are people who think fixed exchange rate between countries is a fact of life. Fixed rates were the prevailing regime in the period between WWII and 1971 when it was ended by the United States which opted for a floating regime in 1973. Still, even now there are many countries who peg their currencies to a major anchor. In fact, the European countries practically peg their currencies to the euro. It should not come as a surprise that national central banks control their currencies and their exchange rates and the Chinese central bank is one of them. Moreover, China had let its yuan appreciate by 21.1 % during the period 2005-2008  and by 2.1 percent in July 2005 alone, but  China's exports to the United States increased by $66 billion dollars during that period. It re-fixed it in 2008 when the world plunged in the Great Recession. Why is it so different now at a time when China had pulled the whole world out of a terrible recession?

Many trade economists do not believe that letting the yuan appreciate will lead to a reduction in U.S. trade deficit for tthree basic reasons. First, the U.S. demand for Chinese exports is inelastic, meaning that increases in Chinese export prices as a result of appreciation in the renminbi, will not lead to a reduction in U.S. imports. This is because there are few substitutes for imported Chinese goods in the United States. Second, an appreciation in the renminbi would make importing of commodities and raw materials by China cheaper than before. Chinese manufacturers can pass the imports' cost savings to exports to the United States and other countries, making Chinese good as competitive as before the appreciation. Third, a good portion of chinese exports to the United States are commodities and capital goods imported from the United States. These three reasons probably explain why the U.S. trade deficit did not drop during the period 2005-2008 after the renminbi appreciated by more than 21%.

What are the ramifications of the United States imposing an appreciation surcharge on Chinese exports? Let us use international trade theory to answer that. Both The United States and China have the first and the third largest economy. Once a large nation imposes surcharges on another large nation, the issue of retaliation comes up. There would be trade and currency wars between the two nations and the two countries will suffer losses in economic growth and social welfare.

It is very likely that China will respond positively and let its currency appreciate when time is right as happened in the period 2005-2008. Currently, it is not the right time as its trade account went into deficit in February 2010, the first  since April 2004.  It will not respond positively to threats at this time. However, building economic pressures including rising inflation and escalating bubbles should force China to revalue its currency. Chinese policy makers will have to continue pursuing restrictive monetary policy that will eventually lead to higher interest rates, which should in turn lead to appreciation of the renminbi.

In the longer term contest, China is decoupling itself from the United States. All of China's acts in terms of the military affairs, diplomacy, climate change, business, politics and economics show strong signs of decoupling. It seems that the dispensability of the United States is becoming more of a reality as time goes on. On the other hand, building a strong consumer base at home, having more influence in Asia and doing business globally are becoming more important than having a strong relationship with the United States. A notion such as "Chindia" may supersede any relationship with the United States over the next two decades.

My guess is Congress’s political bullying will not succeed because it conflates politics and economics at the wrong time and stands in the way of free trade. China is also losing interest in the United States. But most Americans still want to buy Chinese goods. I am one of those. I also see low interest rates and cheap dollar helped by the Chinese are helpful for the American economy at this time. The lack of Chinese participation in the latest Treasury's 10 year autions has led to higher the longer  interest rate in the United States!!!

Congress’s proposed bill is ill-timed. Congress should instead work for peace around the world instead of creating currency and trade wars. The global  market will correct itself on this issue.