Greenspan and Snow Warn Against Unilateral Sanctions on China

Thursday, June 23, 2005

Imposing unilateral trade sanctions on China could have grave consequences to the financial system, Federal Reserve chairman Alan Greenspan warned the US Senate today. "A tariff of 27.5 percent ... if that ever gets implemented the consequences will be extraordinary ... You are getting a former communistic system to recognize that capitalism is where they want to be," Greenspan said in the Q&A session of the Senate's finance committe hearing on trade with China. He went on to say that a unilateral implementation of tariffs could result in great danger to the international financial system. The Chinese as biggest buyers of US debt paper could easily retaliate by simply reducing their bids, Greenspan did not say. Greenspan found an ally in US Treasury Secretary John Snow who also warned against unilateral sanctions in his prepared remarks.
Greenspan said in his remarks that
"any significant elevation of tariffs that substantially reduces our overall imports, by keeping out competitively priced goods, would materially lower our standard of living. A return to protectionism would threaten the continuation of much of the extraordinary growth in living standards worldwide, but especially in the United States, that is due importantly to the post-World War II opening of global markets. Such an initiative would send the adverse message to our trading partners that the United States, while accepting the benefits of broadened world trade, is not willing to absorb the structural adjustments that are often necessary."
In the Q&A session Greenspan pointed out that there was no analytical support that sanctions would be of help in balancing the US trade deficit. "If you go back we have had periods of trade deficits and surpluses intermixing with growing and declining changes the structure of jobs," Greenspan said, adding that structural changes have to come, "...the basic problem we have is a very severe bifurctaion of our labor markets."
The Fed chairman stressed again the point that the US need to improve their educational system as there were too few highly skilled people and too many with low or no skills. The first group would enjoy the benefits of steadily rising wages while the latter one would be at the mercy of the general employment situation, he implied.
Revaluation Would Not Protect Any Jobs
In his introductory remarks he dampened hopes that a revaluation of the Yuan would help creating jobs and reduce the trade deficit. "Some observers mistakenly believe that a marked increase in the exchange value of the Chinese renminbi (RMB) relative to the US dollar would significantly increase manufacturing activity and jobs in the United States. I am aware of no credible evidence that supports such a conclusion," was his first statement to the Senate.
Following are the key statements to the Senate.
An increase in the exchange rate of the RMB, relative to the dollar, would likely redirect trade within Asia, reversing to some extent the patterns that have emerged during the past half decade. However, a revaluation of the RMB would have limited consequences for overall U.S. imports as well as for U.S. exports that compete with Chinese products in third markets. Such a revaluation would affect Chinese value added but not the dollar cost of intermediate goods imported into China from the rest of Asia, which represents a significant share of the gross value of Chinese exports to the United States and elsewhere.
The broad tariff on Chinese goods that has recently been proposed, should it be implemented, would significantly lower U.S. imports from China but would comparably raise U.S. imports from other low-cost sources of supply. At only slightly higher prices than prevail at present, U.S. imports of textiles, light manufactures, assembled computers, toys, and similar products would in part shift from China as the final assembler to other emerging-market economies in Asia and, perhaps, in Latin America as well. Few, if any, American jobs would be protected.
Don't Trade, Produce
A policy to dismantle the global trading system in a misguided effort to protect jobs from competition would redound to the eventual detriment of all US job seekers, as well as of millions of American consumers. Policy should aim to bolster the well-being of job losers through retraining and unemployment insurance, not to stave off job loss through counterproductive efforts to impede the process of income-enhancing international trade and globalization.
Greenspan explained to the Senate committee that China has to work towards a more flexible exchange regime anyway as they have to sterilize the massive inflow of capital or they would otherwise risk creating an inflationary environment with all the problems that follow inflation.
The chairman does not get tired to warn about the devastating effects the close to zero savings rate of the US could have in the long run,
"policies that would enhance national savings are generally good."
An improvement in the current account deficit would come by reducing the budget deficit first, Greenspan said. "We do find evidence that if the federal deficit is brought down 20 cents on the dollar, the current account deficit...follows." But there was no evidence that sanctions would help in balancing the current account deficit.
The Treasury secretary had the following key remarks to the Senate committee.
I cannot overstate my firm belief that resorting to isolationist trade policies would be ineffective, disruptive to markets and damaging to America's special role as the world's leading advocate for open markets and fair trade.
Acting on any of the punitive legislative proposals before Congress now would be counterproductive to our efforts at this time. The unintended consequence would be to delay the concrete steps on currency reform that China should take for its own sake and for the sake of the global economy.
Sanctions Would Provoke Retaliation
In addition, implementation of trade sanctions would lead to retaliatory policies against our exports, damaging the US and the global economy. Walls will not protect America's workers and industry. We succeed not with barriers, but with the openness and dynamism which has always characterized our nation.
Snow made them aware that policymakers will have to act soon in their home-turf if they don't want to be confronted with a financial crisis.
Addressing imbalances in the global economy is a shared responsibility among the major economic regions of the world. While imbalances occur as the patterns of trade and investment flows shift between economic regions, uneven rates of growth in the major economies and inefficient or distortionary policies restrict adjustments and put stress on the global financial systems. Economic policymakers must address these imbalances now; delay increases the risk that adjustments will occur abruptly.
He sees the US on a good path to reduce its budget deficit.
Because of strong growth and appropriate fiscal policy, the U.S. budget deficit in 2004 was well below projections, and with recent data, I expect further improvement in our fiscal deficit position this year. Some private forecasters predict that our fiscal deficit will be below 3 percent of GDP this year if we continue to hold the line on spending.
And he took the steam off the Chinese, pointing out that they have already employed a string of measures towards a more flexible exchange rate system. US politicians seem to put too much of their economic hopes on a revaluation as cure for all domestic problems.
Since 2003, China has taken critical steps to establish the necessary financial environment and infrastructure to support exchange rate flexibility, Snow remarked.
  • It has introduced a foreign currency trading system permitting onshore spot trades in eight foreign currency pairs and allowing banks to act as market makers.
  • It has adopted measures to increase the volume of foreign exchange trading, for example: eliminating the foreign exchange surrender requirement for many commercial firms; allowing domestic Chinese insurance firms and the national social security fund to invest in overseas capital markets; and increasing the amount of foreign currency business travelers can take out of the country.
  • It has taken steps to develop foreign exchange market instruments and increase financial institutions' experience in dealing with fluctuating currencies. Foreign exchange forward contracts can now be offered in China; foreign exchange futures are being developed; and domestic Chinese banks can now trade dollars against other foreign currencies, not just remnimbi.
  • It has also acted to strengthen its financial sector and regulation, so that this sector is more resilient to any fluctuations in exchange rates.
He urged China to proceed with intermediate steps toward a full free-float of the Yuan which would be in the interest of itself. The Yuan/renminbi has been pegged to the dollar at a rate of 8,28 since 10 years.
Altogether Snow has drastically reduced his previously quite aggressive stance towards China's exchange rate policy.
For some background and the recent past of the China issues, jump to these earlier posts.


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