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Empty threats toward China

It's silly season again when holders of high office fulminate about various bogeymen to demonstrate appropriate indignation ahead of elections. Treasury Secretary Timothy Geithner's recent testimony before both houses of Congress was a case in point, as is the bill just passed in the House of Representatives naming China a currency manipulator.

Stop me if you've heard this one before. A large Asian nation rises to wealth on the strength of its exports. As a result, it builds a tremendous amount of dollar reserves — along with the increasing ire of its trading partners. Concerns are raised about how those exports are hurting the U.S. economy. Politicians call on that country to fairly revalue its currency upward in order to stem continued rise in its exports.

Does this sound at all contemporary? It is, but readers of a certain age will also see Japan as the protagonist in this political mise-en-scène. Precisely for this reason, calls for China to revalue its currency will fall flat.

Let's turn back the clock. The year was 1985. The setting was the Plaza Hotel in New York City, and it was Japan that was in the cross-hairs. After years of enduring the unendurable, the G5 agreed to push down the value of the dollar, thereby stemming Japan's export juggernaut. In short order, the yen strengthened from 350 to 250 to the dollar. Not coincidentally, Japan's economy went into a slumber that would impress Rip Van Winkle, and which continues to this day. In fact, just last week, with the Yen approaching 80 to the dollar and Japan's exporters crying for relief from the strong yen, the Bank of Japan took measures to re-weaken the yen. Can China's leaders, seeing this circus nearby, be enthusiastic about accepting Mr. Geithner's advice to revalue their currency upward?

There are legitimate reasons relating to its domestic economy why China might actually want to downshift its export machine to a lower gear, but neither Secretary Geithner nor our Congress chooses to focus on them. Instead, the rhetoric always involves some form of getting tough on China for selling us so much. I frequently wonder exactly what it means to "get tough" with China. An Ahmadinejad-like tirade before the U.N.? Some histrionic oratory at the G20? Perhaps an aggressive application of the Jedi mind trick would do it. Personally, when I hear about getting tough with China, I can't help picturing Larry Fine of the Three Stooges wagging a finger and threatening, "I'm warning you, China!"

A ton of perspective and an ounce of appreciation would be more appropriate. Federal Reserve Chairman Ben Bernanke has had his foot on our monetary accelerator for quite a while during our Great Recession in order to keep our economy maximally liquid. Could he have done so much if not for the benefit of low prices (admittedly imported from China) helping to keep inflation down? How much more difficult would his job have been if he actually had to contend with a big inflationary problem, as we would normally expect after such strong monetary expansion?

But the benefits don't end there. With the dollars gained from selling goods, the Chinese must eventually recycle their money back into our economy. But not for Chinese high-profile purchases like Rockefeller Center, Pebble Beach, Universal Studios and Columbia Studios, as the Japanese undertook. Remember the indignation about that first one in particular? China has largely shied away from similar big-name purchases, preferring to reinvest its greenbacks in plain old U.S. Treasuries instead.

Even so, we're frequently reminded about the potential threat to U.S. interests if China were ever motivated to dump its holdings.

Far too many people think our estimable Fed chairman controls interest rates in the United States. In actuality, on consumer loans like mortgages, he does nothing of the sort. Long-term rates like mortgages are related to similar term rates on the benchmark bond. What might that be? It just happens to be the same Treasury bonds that Chinese exporters have been buying in such abundance.

It's a financial tautology that bond prices and interest rates move in opposite directions. Therefore, this has actually constituted a second front of sorts in Chairman Bernanke's unenviable war on interest rates. His already difficult job would have been considerably more so if he hadn't received this assist from China, pressing bond prices up thus keeping interest rates low.

Napoleon Bonaparte once proclaimed, "Quand la Chine s'éveillera, le monde tremblera" ("When China wakes, she will shake the world"). By incontrovertible consensus, China is wide awake, and its impact on global economic dynamics is unavoidable. Raging at China may play at the polls and in the court of U.S. public opinion, but it will accomplish nothing economically.

Michael Justin Lee, former Financial Markets Expert-in-Residence in the U.S. Department of Labor, teaches international finance at the University of Maryland's Robert H. Smith School of Business. His e-mail is leem@umd.edu.

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