Opening Remarks June 23, 2010, 11:01PM EST

Five Options for Tackling Trade With China

The U.S. needs much more than an exchange-rate "head fake" from Beijing to correct the glaring trade imbalance. Policies must be challenged

By Peter Coy

For one day—Monday, June 21—America's economic relations with China seemed to be on the right track. The Chinese currency jumped in value following a weekend announcement by the People's Bank of China that it would increase the flexibility of the exchange rate. A stronger yuan raised hopes for U.S. exporters trying to penetrate the booming Chinese market and gave domestic American producers competing with cheap Chinese imports a much-needed boost at home. Treasury Secretary Timothy Geithner said China's move would "make a positive contribution to strong and balanced global growth."

On June 22, the relationship was back to normal. The yuan gave up half of the previous session's gains as traders concluded that the central bank's commitment to flexibility did not imply a large and sudden increase in the yuan's value. U.S. labor leaders and some members of Congress argued that China's announcement was timed to deflect criticism by the U.S. and other nations at the Group of 20 summit in Toronto on June 26 and 27. "It looks to me like it was kind of a head fake. They're not contemplating anything like what we need," says Clyde Prestowitz, president of the Economic Strategy Institute, a Washington consulting firm.

The episode conveys an important lesson about the prolonged stress in U.S.-China economic relations: There's no easy solution that will suddenly make the superpowers synergistic. Americans blame China for not letting the yuan rise significantly, for not enforcing U.S. patents, for not putting American-made products on an equal footing with Chinese ones. China blames the U.S. for not putting its own fiscal house in order. Beijing fears that any rapid policy change would spur domestic unemployment and social instability. As China grows, U.S. influence shrinks. "What we're finding is that the United States is bumping up against the limits of the tools that it's had available," says Evan A. Feigenbaum, a Deputy Assistant Secretary of State in the George W. Bush Administration who heads the Asia practice at the Eurasia Group, a New York-based consultancy.

The U.S. can't just ignore China. It's the fastest-growing major economy in the world, at around 10 percent annually since the mid-'90s. The U.S.-China Business Council points out that exports of U.S. goods to China have risen 330 percent since 2000, vs. an increase of just 29 percent to the rest of the planet. And cheap imports from China have held down the U.S. cost of living.

What, then, can the U.S. do to get the most out of its economic links with China? Here are a few options:

1. Block China: In a March New York Times column, Paul Krugman, the Nobel laureate Princeton University economist, advocated for the U.S. to impose a temporary 25 percent tariff on imports from China until the country meaningfully raises the value of the yuan. Krugman elaborated on his argument in an interview with Bloomberg Businessweek, saying that by keeping its currency undervalued in a period of sluggish global demand, China is, in effect, exporting its unemployment problem to the U.S. "It's a world where mercantilism actually works and hurts the other guy," Krugman says. Even if China refuses to back down on the currency clash, Krugman argues, the U.S. would come out ahead because the tariffs would create more jobs at home without causing inflation.

The problem with unilaterally imposed tariffs is that China would undoubtedly protest them at the World Trade Organization—and might well win sanctions, forcing the U.S. into an embarrassing retreat—or worse, deliberate defiance of the global trading rules it helped invent, says Morgan Stanley Asia (MS) Chairman Stephen Roach. "You don't suspend the rules of free trade during recessions."

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