Summers in Beijing

What was the administration trying to achieve by sending Larry Summers to Beijing? What message was it trying to convey? And was the intended audience American or Chinese?

Taken at face value, Dr. Summers, as head of the National Economic Council, was there to deliver a message about American economic concerns. Foremost among these has been the stubborn stasis in China’s exchange rate against the dollar. If this was the real purpose of his trip, he achieved little; the Chinese did not even pretend to accommodate. According to the Wall Street Journal:

Chinese officials have consistently said that they won’t change key economic policies because of foreign pressure, and argued that the exchange rate has little bearing on the U.S. trade imbalance with China. "Our exchange rate reform can’t be pressed ahead under external pressure," Foreign Ministry spokeswoman Jiang Yu said at a regular press briefing Tuesday.

If Dr. Summers’ mission was to describe mounting political pressure in Washington, it is not clear what he could have said that would have surprised his hosts. The Chinese have certainly already heard of Sen. Schumer (D-NY) and they have undoubtedly read the Ryan-Murphy bill in the House.

More likely, Dr. Summers’ participation was intended for a U.S. domestic audience. He needed to be there alongside deputy National Security Advisor Tom Donilon. There were sound reasons for a security conversation with the Chinese, from sanctions on Iran to a restoration of a dialogue between the U.S. and Chinese militaries. Donilon could have accomplished that on his own, but it would have been politically unacceptable for an administration trying to focus on job creation to appear to neglect economic concerns with China.

The Obama administration is in a difficult spot in its economic diplomacy with Beijing. By failing to object, it has tacitly conceded the flawed but popular argument that China’s exchange rate policy is an important determinant of American job creation. Now the administration finds itself with few levers to move the RMB, which hovers roughly where it has since 2008, despite a Chinese announcement of new flexibility in June. Thus, the administration is left pursuing a policy of repeated bilateral beseeching, so far with little to show.

It reached this unfortunate juncture, in large part, because of a decision to allow the currency question to take center stage. The fixation with China’s currency has been long-standing in Washington and is the rare issue that finds some bipartisan agreement. Yet the economic case for this fixation is not particularly strong.

The most prominent advocates for Chinese revaluation as a cure for U.S. economic woes have argued that an appreciation would boost demand for U.S. goods, shrink the U.S. trade deficit, and thereby create an appreciable number of new jobs. Some evidence for the efficacy of exchange rate moves comes from the redoubtable Bill Cline, of the Peterson Institute. He provides statistical evidence that China’s trade balance does respond to exchange rate moves. In making this argument, he is countering the critique that China’s sole significant episode of exchange rate appreciation, from 2005 to 2008, was accompanied by a growing trade deficit. Cline shows that the more conventional relationship between exchange rates and trade balances does hold, only with a lag of about a year or two. He explains:

The lag reflects the time it takes for the exchange rate signal to be interpreted as more than a temporary fluctuation, and the additional time for resulting production decisions and trade flows to materialize.

Practical interpretation: Chinese currency revaluation cannot provide a quick fix to the U.S. economic predicament. We will have to wait quite a while, Cline’s estimates show, for the full effects of any future Chinese moves to kick in.

There were certainly ready alternatives that the administration might have selected as a focus of its economic diplomacy toward China. In its 2010 White Paper on doing business in China, the American Chamber of Commerce in China reported:

…while currency is an important issue, AmCham-China is concerned that the US is placing disproportionate emphasis on RMB valuation. The current trade imbalance with China has not significantly affected America’s overall trade deficit, but has rather absorbed shrinking deficits with other Asian countries like South Korea and Japan. Moreover, RMB revaluation would likely result only in a modest decrease in the current trade deficit between the US and China, while focusing on other price distortions, such as factor pricing in China, would possibly result in greater adjustments.

To change the U.S. focus to issues like factor pricing (the cost of labor or resources within China) or China’s industrial policies would have been politically difficult for the administration. President Obama campaigned on attacking China as a currency manipulator and Democrats excoriated the Bush administration for failing to persuade China to appreciate faster than it did (roughly 20% from 2005 to 2008). To pivot would have meant a battle with a committed constituency. Not to pivot meant a gamble that China could be persuaded to put U.S. interests above its own perceived core concerns.

Even for the accomplished Dr. Summers, that has proven a difficult task.