The US Congress just doesn’t do macro

It sounds like both the United States Congress and Stephen Roach were in rare form last week as the subject of currency manipulation by Asian exporters was discussed. From this account of what happened, it looks like trade sanctions are coming.

Even the old timers in the Congress had never seen anything like it. On May 9, the US House of Representatives held what was billed as a tripartite hearing of three subcommittees on “Currency Manipulation and Its Effects on US Businesses and Workers.” I was one of the “expert witnesses” at this hearing – invited to submit a written statement and then, along with the other six members of the witness panel, to present a five-minute oral summary in front of the assembled legislators (my written statement, “A Slippery Slope,” was published as a Morgan Stanley Special Economic Study on May 9). The hearing concluded with an extensive question and answer session. It was an experience I will never forget. My worst fears were realized. At the end of over three hours of grueling give and take, I left Capitol Hill more convinced than ever that the protectionist train has left the station.
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In terms of the substance of the debate, three things surprised me about this hearing: First, while the bulk of the discussion was about China, anti-Japan sentiment was formally brought into the picture for the first time. The issue was the yen – characterized by the Congress as the world’s most undervalued major currency. While the absence of explicit intervention by Japanese authorities over the past three years was duly noted, many representatives took the position that there has been unmistakable “implicit manipulation” of the yen. Second, the case against China was framed mainly around the concept of the “illegal subsidy” – WTO-compliant jargon that frees up Congress to impose sweeping countervailing duties on Chinese exporters. Taking a cue from Federal Reserve Chairman Ben Bernanke’s mid-December 2006 speech in China, Congress seems willing to support the Hunter-Ryan bill (H.R. 782), which argues that an undervalued RMB qualifies as a subsidy that is grounds for a WTO dispute (see Bernanke’s December 15, 2006 speech, “The Chinese Economy: Progress and Challenges”). Third, the congressmen present at this hearing were highly critical of the US Treasury’s bi-annual foreign exchange review process and its failure to cite China for currency manipulation. This puts the House on a similar track as the Senate – especially that espoused by the leadership of the Senate Finance Committee, whose Chairman (Max Baucus) and ranking minority member (Charles Grassley) endorsed a similar approach last year. That is the first hint at a reconciliation strategy between the two chambers of Congress – particularly important if they are to go into a joint conference later this year after passage of their own trade bills.

Notwithstanding these new developments, the most important message is that Congress remains unwavering in its determined approach to move from rhetoric to action in 2007 on matters of trade policy.
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There’s always a chance that I’m over-reacting to an escalation of Congress’s rhetorical assaults on China – that this will just be another year of bluster. Anything is possible when it comes to Washington. But I have spent more time on Capitol Hill in the past three months than at any point since I left the Fed in 1979. Since mid-February, I have testified three times on US-China trade frictions, and in each of these instances, I have seen steady progression toward a protectionist endgame. On the basis of everything I have heard over the past several months, I remain more convinced than ever that Congress has finally thrown down the gauntlet. The May 9 tripartite hearing hammered that point home with disturbing clarity. As Barney Frank, Chairman of the House Financial Services Committee, said, “This problem is not going away. We are going to have to act.” If Congress changes its mind and backs away, it fears it will lose all credibility on this key issue with American workers. With respect to China, I am afraid that means the US Congress has now gone past the point of no return.

Other accounts of the session dealt with the implications of revaluing the Chinese currency. Elected officials were warned that retaliating against China would be "a policy blunder of monumental proportions" (the same phrase he used to characterize Alan Greenspan's 2001-2004 interest rate policy) and that the low U.S. savings rate was responsible for the U.S. trade deficit (i.e., the U.S. just spends too much using borrowed money).

He added that the Chinese are not likely to follow the example of the 1985 Plaza Accord where Japan allowed their currency to strengthen by almost 50 percent against the dollar in order to counter a trade imbalance leading to asset bubbles and the 1990s deflation that persists to this day.

This might get very interesting, very soon.

ooo

This week's cartoon from The Economist