Krugman on Right Track With Chinese Tariff

Includes: CNY, CYB, UDN, UUP
by: Howard Richman

In a commentary in Sunday's New York Times (Taking on China), Nobel Prize winning economist Paul Krugman called for an across the board 25% tariff on Chinese goods. Here is his specific recommendation:

In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. At this point, it’s hard to see China changing its policies unless faced with the threat of similar action — except that this time the surcharge would have to be much larger, say 25 percent.

Krugman dismisses widespread defeatism concerning Chinese retaliation, arguing that America has little to fear from China dumping U.S. assets. He points out:

It’s true that if China dumped its U.S. assets the value of the dollar would fall against other major currencies, such as the euro. But that would be a good thing for the United States, since it would make our goods more competitive and reduce our trade deficit. On the other hand, it would be a bad thing for China, which would suffer large losses on its dollar holdings. In short, right now America has China over a barrel, not the other way around.

Krugman is definitely on the right track. He is suggesting that the tariff rate should be proportional to the Chinese currency value. Since the Chinese currency is 20-40% undervalued, the rate should be 25%.

However, China's trade manipulations involve much more than just currency manipulations. China could retaliate, for example, though tariff and non-tariff barriers to American products, as when it recently placed tariffs on American nylon products and chicken parts.

In order to prevent such retaliation, the tariff rate should be announced as being proportional to U.S.-China trade deficits. Not only are these trade deficits a concrete measure, but they also give the tariff legitimacy since there is a special WTO rule which lets trade deficit countries apply import duties in order to balance trade.

With this mechanism in place, if our trade deficit with China comes down, the tariff rate would come down; if our trade deficit with China goes up, the tariff rate would go up. If our trade with China reaches relative balance, the tariff would disappear.

One of the Chinese government's biggest trade manipulations involves its lists of approved products. Ambrose Evans-Pritchard just reported that China is now threatening to keep Boeing (NYSE:BA) commercial aircraft from its approved lists. He wrote:

What interests me is Beijing's willingness to up the ante. It has vowed sanctions against any US firm that takes part in a $6.4bn weapons contract for Taiwan, a threat to ban Boeing from China and a new level of escalation in the Taiwan dispute.

These Chinese government lists determine which products can be purchased by the Chinese government or by government-owned businesses, or with government subsidies. China uses these lists of products to keep out foreign products. In 2009 they were able to grow their economy by 8.7% without increasing imports of American goods.

American companies have long understood that if they want access to the growing Chinese market they must move their factories to China. In December, China made a new rule requiring that foreign companies also move their Research and Development facilities and patents to China, and Pfizer (NYSE:PFE) has already announced that it is moving its R&D facility from Connecticut to China.

Krugman is on the right track. But if we want to solve the problem, we need to require balanced trade.

Disclosure: I own Chinese yuan through CYB