Chuck Schumer and the China Currency Bill

Chuck Schumer and Sherrod Brown have got through the Senate the China Currency Bill (formally, the “The Currency Exchange Rate Oversight Reform Act”) and I’m sorry to have to say this but it’s one of the more stupid pieces of legislation that I’ve seen. It isn’t actually addressing a real problem, won’t solve the non-problem it’s addressed at and risks a trade war to boot. In my more cynical moments just what I expect from the political process.

I’m not alone in such views, here’s Barron’s:

Schumer-Somebody could surpass Smoot-Hawley in its current form. If it becomes burdened with hundreds of extra special-interest provisions, as Smoot-Hawley was, and wins passage because of them as Smoot-Hawley did, Schumer-Somebody will retire the trophy.
All we can do is hope that Schumer doesn’t find his Somebody, and that House Speaker John Boehner stands firm in his resolve not to bring the trade bill to the floor.

I think we can assume that they’re against it.

But over and above this risking of a trade war, something we really don’t want to risk in the middle of economic hard times, there are two more much more important reasons why it’s just not going to do what the Senators think it will.

The first is their analysis of the basic problem. As Scott Sumner points out, China has already revalued the yuan:

There really isn’t any “problem” at all, but the perception is that the yuan is getting increasingly undervalued. Back in 2005, Chuck Schumer said the yuan was 27.5% undervalued, and he demanded a revaluation. China has more than complied with this request; the yuan has increased by nearly 30% in nominal terms and more than 50% in real terms. So is Chuck Schumer happy now? Not quite. He now insists the yuan is 32.5% undervalued, and demands another massive revaluation. All this despite the fact that the previous revaluation didn’t reduce the deficit by 1 cent; indeed the deficit got bigger.

We can actually go further than this as well. It isn’t the “exchange rate” that is even conceivably the problem, even by the standards of Senators Schumer and Brown. It’s the cost of labour which is and that has been rising even faster:

There’s more to the story than that, however. What really matters for jobs and competitiveness is not consumer price inflation, but the rate of change of unit labor costs. (Unit labor costs are wage rates adjusted for changes in productivity.) A recent study from the Boston Consulting Group suggests that Chinese unit labor costs will grow at about 8.5 percent per year over the next five years. Meanwhile, U.S. unit labor costs in manufacturing, where the head-to-head competition for jobs lies, have been on a steady downward trend, because productivity growth has been strong and wage increases moderate. The most recent data, which show a tiny upturn, are the first increase in 10 quarters.
Conservatively speaking, then, it appears that over the past couple of years, the real exchange rate of the yuan, deflated by unit labor costs, has been appreciating against the dollar at a rate of something like 15 percent per year. Even if the U.S. unit labor cost trend flattens out, a continued 10 percent rate of appreciation appears likely.
Let’s remember that back in the spring of 2010, when the Chinese were still holding firm to their peg of 6.82 yuan to the dollar, the maximum demand being made by American China-bashers was a 40 percent revaluation. In the fifteen months have elapsed since the peg was abandoned, a third, maybe even half, of the gap has vanished. At the rate things are going, the yuan will reach parity against the dollar, measured by unit labor costs, about two years from now, possibly sooner.

So even if Schumer and Brown are correct, the problem is already solving itself and we just don’t have to go risking a trade war to solve it.

The second reason that it won’t work is that the original analysis itself is wrong. Currency values work both ways you see. Yes, sure, if the yuan (or renmimbi, either name works) were to rise against the US dollar then yes, Chinese labour as expressed in US dollars would rise in price. But all the imports which are put together by that Chinese labour would fall in price in yuan terms. Or remain the same in US dollar terms of course.

What effect would it have, changing the price of Chinese labour a bit (less, as we’ve seen, than it is changing already) but leaving the prices of what it assembled by that labour the same as they were?

Well, why not look at the iconic products of our age, Apple’s iPods, iPhones and iPads? Yes, bringing one in from China to sell in a US store adds, in the headline numbers, some hundreds of dollars to the trade deficit with China. But how much of that is actually about Chinese labour, or the price of Chinese labour which is the thing that we’ll be changing?

Not a lot actually:

That means that the main financial benefit to China takes the form of wages paid for the assembly of the product or for manufacturing of some of the inputs. Many components, such as batteries and touchscreens, receive their final processing in China in factories owned by foreign firms. Although hard facts are scarce, we estimate that only $10 or less in direct labor wages that go into an iPhone or iPad is paid to China workers. So while each unit sold in the U.S. adds from $229 to $275 to the U.S.-China trade deficit (the estimated factory costs4 of an iPhone or iPad), the portion retained in China’s economy is a tiny fraction of that amount.

So, let us assume that the China currency bill actually works as Schumer and Brown desire: China realises the errors of its ways, floats the yuan and the yuan rises 30% against the US dollar. The effects of this on the manufacturing costs of an iPad or iPhone will be, umm, about $3. No, really, three bucks, that’s it. 30% of the value added in China, 30% of that $10 which is the Chinese labour embedded in one of the machines.

All the rest of it is imported components or imported knowledge, patents and copyrights. A rising yuan leaves these prices unchanged in US dollars or makes them fall in yuan terms.