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Bernanke, Chinese currency subsidies and the "P" word

By Peter Morici
web posted December 18, 2006

In the prepared text for a speech at the conclusion of high-level meetings in China, Ben Bernanke noted that China's undervalued yuan provides an "effective subsidy" for firms that "focus on exporting." He used the word subsidy three times in prepared remarks but backed away from this language in his actual speech.

Press coverage noted the rash of "protectionist" legislation on Capitol Hill, and that such an acknowledgement of Chinese policies would place pressure on the Bush Administration to take such actions.

This constant reference to prospective measures to offset Chinese currency subsidies as "protectionist" is an unfortunate and misleading use of language that has no sound basis in WTO law or the economics of the situation.

By any reasonable reading of the WTO rules, Chinese currency intervention is an export subsidy. China's currency intervention provides a monetary benefit to exporters by putting yuan in the hands of foreign purchasers, and for Chinese businesses to gain access to this benefit, they must export.

WTO rules treat export subsidies as among the most egregious forms of protectionism, because these directly impede free trade based on comparative advantage. Export subsidies lower GDP, globally, by fostering imprudent investments and the inefficient use of labor and capital both in the exporting and importing countries. WTO rules strictly prohibit export subsidies, and empower importing nations to impose countervailing duties or tariffs to neutralize and essentially suspend their harmful effects, if the exporting country will not cease these practices.

As things stand, Chinese GDP may be raised by Beijing's intervention in currency markets to lower the dollar value of the yuan; however, U.S. and EU GDP are lowered by even more, and global GDP is reduced on net. This is a basic theorem of modern international economics and comparative advantage. Americans do not perceive this income loss, because we are borrowing from China to make up the difference, but that debt will require burdensome interest payments in the future.

A countervailing duty or tariff, which removes the benefit bestowed by an export subsidy, is considered a reasoned and measured response under WTO rules and NOT protectionist. The Bush Administration has been shy about using the subsidy word, because acknowledging Chinese currency intervention for what it is would require such a non-protectionist reaction. It has been convinced by economists at Treasury with strange gaps in their formal training, of which Mr. Bernanke is not one, that Chinese currency subsidies are somehow different from other export subsidies.

The press and the Bush Administration should find another word to use rather than "protectionist" to describe legitimate self defense against an aggressive mercantilist practice like currency manipulation.

China may need a stable currency for developmental purposes. However, that purpose could be served by a yuan pegged at 4 or 5 to a dollar instead of 7.82. That would not require persistent sale of yuan for dollars and euro in currency markets and would not create an export subsidy.

A lot of blue collar workers are losing jobs in industries where the United States enjoys a comparative advantage, thanks to subsidized imports from China that would not be profitable at a market based exchange rate, even if fixed by Beijing. Redressing the harm ordinary working Americans endure would not be protectionist but merely self defense. ESR

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.


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