Greenspan Goes to China

Irwin Stelzer tells us what's at stake with Alan Greenspan in China this week.

First of all, the Treasury Dept. is grappling with whether it should call China a currency manipulator in a report it is scheduled to deliver to Congress this month. If Secretary Snow tells Congress what everyone seems to know, it will fuel the desires of Chuck Schumer and his protectionist colleagues to impose stiff tariffs on Chinese imports. China, of course, is funneling the dollars it receives from exports to us back into U.S. Treasury notes, thereby keeping the dollar artificially overvalued and the Chinese Yuan artificially undervalued. Additional consequences of China's aggressive purchases of U.S. debt are the buoyant price and low yield of that debt, fuelling the American housing market and the activity of the American consumer borrowing against his seemingly ever-appreciating real estate.

Greenspan, however, fears that "rampant protectionism can bring on a worldwide recession," as Stelzer puts it. Stelzer speculates that Bush is gambling on Greenspan's prestige lending credibility to arguments that the Chinese are moving in the right direction (away from pegging their currency to the dollar) and that there are many causes to the deficit, making Democrats think harder before imposing tariffs. However, Bush also runs the risk of "a public dressing down" by Greenspan, according to Stelzer, because of his profligate spending. Deficit spending can lead to inflationary symptoms even in the face of an economic slowdown ("stagflation"), forcing the Fed to tighten and impose a cure almost as painful as the illness.

Additionally, Stelzer notes, the high price of oil is sending more dollars to the Middle East and to Japan (for its fuel-efficient cars) instead of Detroit, making it difficult to single out Chinese imports as the culprit of the trade deficit. Moreover, even if the Chinese reduce their "peg" to the dollar, their labor costs are so much lower so that they'd still dominate markets for textiles and other labor-intensive products.

Finally, if Congress has its way and imposes tariffs on Chinese goods in retaliation for Chinese currency manipulation (or China stops manipulation of its own accord), not only will the dollar weaken but interest rates will go up, ending mortgage refinancing and sending home values down. In other words, the American consumer will feel and, in effect, be poorer, jeopardizing continued economic growth.

So, as Stelzer nicely concludes, Greenspan has the difficult task of persuading the Chinese to remove the "peg" quickly enough to calm Congress but slowly enough not to burden his successor with a currency crisis. If he can pull that off before he steps down in January, it would be an impressive final act.