US should recall 1930 when considering China tariffs
William Peseknull  Updated: 2005-06-09 09:13

In the battle between the United States and China over the yuan, all eyes are on Beijing. It may make more sense to look to the U.S. state of Iowa, more specifically, to its Republican senator, Charles Grassley.

What has been lost in the escalating tit for tat over China's currency peg is the economics of the issue. For a reminder of what's at stake, U.S. lawmakers should consider comments that Grassley made in an April 26 Bloomberg News interview.

Asked why he wasn't supporting a proposed 27.5 percent tariff on Chinese imports unless Beijing relaxed the yuan's 8.3 peg to the dollar, Grassley said, "I saw it as an opening of the doors for Smoot-Hawley."

The reference here is to a congressional move in 1930 that raised tariffs on imported goods by as much as 60 percent. Other nations, of course, followed suit, imposing retaliatory tariffs. It was perhaps the last thing the global economy needed on the heels of 1929's stock-market crash.

"You know, when you talk about a 27 percent tariff if a country doesn't do something the way we want them to do it, then, you know, that's what we did with Smoot-Hawley in 1930, and that brought on the Great Depression," said Grassley, whose state was hit hard by those tariffs. "Protectionism would be started by the United States, not ended by the United States. So we got to find some other way of doing it."

The magnitude of the fallout from the Smoot-Hawley Act is debatable. Arguments by supply-side-economics enthusiasts that it caused the Great Depression ignore the Federal Reserve's culpability in the most infamous U.S. boom-and-bust cycle. Still, taking steps that hurt farmers and curtailed international trade hardly helped.

All this should offer a cautionary tale to U.S. lawmakers looking ahead to their next election. As we see with each passing day, threats from U.S. senators like Charles Schumer of New York and Lindsey Graham of South Carolina - who sponsored the China tariff legislation - are falling flat in Beijing.

If they are wondering why, they need only read recent comments by Deputy Finance Minister Lou Jiwei. China Business News quoted Lou as saying that his country wasn't yet ready for a floating currency and that the timing of even small changes to the peg should be left to the best judgment of Chinese officials.

Warnings of trade sanctions leave China less willing to let the yuan rise in the near term. They also show how little leverage the once mighty U.S. Treasury Department has over officials in Beijing.

The intractableness of China's position may reflect not stubbornness but real concerns about the underlying state of Asia's No. 2 economy.

One barometer of China's challenges is its stock markets. While stock indexes don't always correlate with gross domestic product, how could the Shanghai Composite Index be down more than 18 percent this year amid 9 percent growth?

The explanation goes beyond inadequate corporate transparency and governance. One also has to look at China's rickety financial system, which is weighed down by hundreds of billions of dollars of bad loans. There's also reason to worry about the viability of more recent loans that could turn bad amid efforts to slow the economy.

One concern is that some, or much, of the 20 percent increase in bank lending in each of the past two years was directed by government officials into unprofitable state-owned enterprises. Another concern is a steady increase in consumer credit in a nation unaccustomed to managing debt.

All this can be seen in the plans of Bank of Communications, which is seeking to raise as much as 14.9 billion Hong Kong dollars, or about $1.9 billion, in the first of three overseas share sales by China's banks this year.

Bank of Communications, the fifth-largest Chinese lender, is offering the shares at a lower valuation than the biggest banks in Hong Kong thanks to concerns about the nation's nonperforming loans, said Christopher Wong at Aberdeen Asset Management in Singapore.

Until China's financial system is ready for prime time, it may leave its currency peg alone. That underscores the futility of tariffs. No one is saying that China is in full compliance with its World Trade Organization responsibilities, yet there is a risk of unintended consequences from attaching trade penalties to currency values.

The most obvious one is a trade war that leads to a kind of tariff arms race between the United States, China and Europe. China would certainly retaliate, upping the stakes elsewhere.

Given the interconnectedness of the global economy today - the United States needs cheap Chinese goods and for China to buy more U.S. Treasuries, for example, and China needs U.S. demand - it's in no one's best interest, least of all American corporations relying more and more on cheap Chinese labor to fatten profit margins.

It's odd, really. In Washington, the belief seems to be that China is exploiting U.S. workers, when it is really their employers exploiting Chinese's ample supply of low-wage laborers.

Bottom line, there's arguably no greater risk to U.S. corporate earnings and hiring activity than problems with the U.S.'s commercial ties with China.

It's fine to deal with trade disputes. Yet, as Iowa's Grassley points out, knee-jerk protectionism of the kind making the rounds on Capitol Hill isn't the answer. By punishing China for its currency stance, Congress may just be cooking up a new and improved Smoot-Hawley debacle.

The above content represents the view of the author only.

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