U.S. Senate Courts Trade War With China

by: Kurt Brouwer

When times are tough and economic activity is weak, politicians love to blame foreigners for our problems. Today, we find out that the U.S. Senate is attacking China because the Senate wants a weaker dollar versus the Chinese yuan. I’m not kidding. The Senate wants the dollar to fall against the yuan in the vain hope that it will stimulate manufacturing here. Of course, the dollar has been weak for years, so that seems unlikely.

Killing the U.S. dollar

Killing the dollar has been federal policy for years. The Federal Reserve has been the main instrument of our weak dollar policy by maintaining low short-term interest rates, which in turn ensure that the dollar remains weak. When the Fed raises short-term interest rates, the dollar strengthens. When the Fed cuts rates, the dollar falls. Unfortunately, now the Fed has cut rates to essentially zero and we are still stuck with a weak economy plus a weak dollar. Let’s take a look at how the dollar has fared against major currencies since 1990. Back then, our interest rate policy and support for the dollar kept it pretty strong. Then, in 2001 that changed as this chart shows:

Click to enlarge

Click to enlarge

Source: St. Louis Federal Reserve [Red Title Added: KB]

Former Fed Chairman Alan Greenspan began cutting short-term interest rates, beginning in late 2000. That made sense given that the economy was starting to slow, but then he made a grievous error. He lowered Fed Funds to levels we had not seen since 1961. For example, in December 2001 Fed Funds went down to 1.62%. The rates did not go up to 2%+ until December 2004, even though the recession ended in November 2001. This policy was disastrous for the dollar, but it also had many other adverse effects in promoting unwise borrowing.

Ben Bernanke, took Greenspan’s low interest policy and carried it much further into dangerous territory when he went to an essentially zero interest rate policy (ZIRP) in late 2008. Bernanke recently compounded that error by declaring that ZIRP would be in place for two years. Lately, due to the crisis in Europe, the dollar has rebounded and shown some strength. That has slowed the relative appreciation of the Chinese yuan-- so what does the U.S. Senate do? Does it applaud the stronger dollar? Does it seek additional ways to have a strong and stable currency? No, it blames China for not letting its currency go up versus the dollar. In other words, the Senate wants a weaker dollar.

Blaming China and igniting a trade war

Here is the background on this latest lunacy from the Senate. This MarketWatch.com piece has the details [emphasis added]:

China criticized a U.S. Senate decision to move ahead with a bill designed to pressure Beijing on its currency policy, saying the move fosters distrust and could spark a trade war. Such a move “seriously violates rules of the World Trade Organization and obstructs China-U.S. trade ties,” Foreign Ministry spokesman Ma Zhaoxu was quoted as saying in a Tuesday report by the state-run Xinhua News Agency.

Ma was quoted as urging U.S. lawmakers to “rationally understand the Sino-U.S. trade cooperation, which is mutually beneficial in nature.”

Xinhua cited data as showing that China ranks as the fastest-growing export market for U.S. goods and that the two countries rank as each other’s second-largest trading partners…

The key point is that the Chinese have been allowing their currency, the yuan, to gradually move up against weaker currencies such as the dollar. In other words, the Chinese have been quite responsible in managing their own currency. Now the Senate threatens to impose tariffs on Chinese goods because China has been measured in its currency approach.

MarketWatch.com continues:

U.S. senators on Monday voted 79-19 to cut off debate on the measure, paving the way for a final vote as soon as later this week. House Republican leaders are cool to the bill, however, and the White House hasn’t endorsed it…

The bill would have to pass the Republican-controlled House of Representatives and then be signed by President Barack Obama in order to become law.

Analysts said China already has a bias toward gradual appreciation of its currency and the tactic could end up being counterproductive.

“If anything, it’s going to make it more difficult to continue with currency appreciation because they don’t want to be seen as giving into external pressures,” said Royal Bank of Canada strategist Brian Jackson in Hong Kong…

A strong & stable dollar

Hopefully this mess will get quietly shelved, but protectionist trade measures have surprising power in weak economic times. I may be naive, but I believe we should get our own house in order before criticizing others. I also believe we should actually carry out a true policy of having a strong and stable dollar.

Disclosure: No positions