Foreign Correspondence

[StephanieVanbryce]

Greenspan Warns Against Raising Tariffs on China

by: Joseph Rebello & Elizabeth Price, Staff Reporters for The Wall Street Journal

Washington - Federal Reserve Chairman Alan Greenspan warned Congress Thursday that a big increase in tariffs on Chinese imports would "materially lower" U.S. living standards and urged lawmakers instead to let financial markets resolve trade imbalances with that country.

But, in testimony to the Senate Finance Committee, Mr. Greenspan said China ought to adopt a more flexible currency regime for the sake of its own economic stability and for the sake of "all participants in the global trading system."

The Fed chairman urged the Chinese government to act speedily to alter the fixed exchange rate system it has had for the last decade, saying "the sooner ... the better."

Treasury Secretary John Snow also said China must introduce a more flexible currency system and open its economy to more imports in order to head off a dangerous wave of trade protectionism around the world.

"Nothing would do more damage to the prospects of increasing living standards throughout the world than efforts to inhibit the flow of trade," Mr. Snow said in prepared testimony to the Senate Finance Committee, where he was appearing with Mr. Greenspan. "However, it is incumbent on China to address concerns before mounting pressures worldwide to restrict trade harm the openness of the international trading system."

The Chinese government manages its currency through intervention and a system of capital controls that effectively pegs its currency at 8.28 yuan to the U.S. dollar. For nearly two years the Bush administration has publicly urged China to move to a more flexible system. China's leaders have said they want to do so, but can only move when the banking system reforms sufficiently to handle the adjustment.

The delay has provoked impatience in Congress, where a raft of legislative proposals would impose trade sanctions on Chinese imports in retaliation for the currency peg.

One bill, sponsored by Sens. Charles Schumer, a New York Democrat, and Lindsey Graham, a South Carolina Republican, would impose 27.5% tariffs on imports from China if Beijing doesn't allow its currency to appreciate within a period of 180 days. That measure, in an amendment to unrelated legislation, recently attracted 67 votes in favor -- a very strong statement of support from both political parties. Messrs. Schumer and Graham agreed to withdraw it after Senate leaders promised a stand-alone vote this summer.

Mr. Snow said these proposals, if enacted, would not only harm the U.S. economy, but would also delay any action by the Chinese government to loosen its peg. "I cannot overstate my firm believe that resorting to isolationist trade policies would be ineffective, disruptive to markets and damaging to America's special role as the world's leading advocate for open markets and fair trade," Mr. Snow said. Imposing trade penalties on China would likely provoke Chinese retaliation against U.S. exports as well, he added.

Mr. Snow repeated that China's currency peg has become "distortionary" to world financial markets and hinders China's ability to control inflation in the economy. He again said that the most effective strategy for reducing global trade imbalances is for Asia countries to allow more flexible currency markets, faster economic growth in Europe and Japan, and raising savings in the U.S.

Mr. Greenspan said that the U.S. government shouldn't dictate precisely how China should change its fixed exchange-rate system, saying Chinese authorities are better-equipped to find the right remedy.

Mr. Snow also said the U.S. budget deficit should fall to below 3% of gross domestic product this year, if Congress keeps spending under control. "We are also working to put in place innovative policies to increase the savings rate," he said.

Mr. Greenspan told lawmakers that a steep increase in tariffs would be counterproductive, hurting U.S. consumers without reducing the overall U.S. trade deficit. "The broad tariff on Chinese goods that has recently been proposed would significantly lower U.S. imports from China but would comparably raise U.S. imports from other low-cost sources of supply." Prices of U.S. imports, he said, would rise slightly but "few, if any American jobs would be protected."

"More generally, any significant elevation of tariffs that substantially reduces our overall imports, by keeping out competitively priced goods, would materially lower our standard of living," Mr. Greenspan said. "A policy to dismantle the global trading system in a misguided effort to protect jobs from competition would redound to the eventual detriment of all U.S. job seekers, as well as millions of American consumers."

Mr. Greenspan played down the significance of the U.S. trade deficit with China, which reached a record $162 billion at the end of 2004. "The widening of the United States' bilateral trade deficit with China, measured gross, has been largely in lieu of wider deficits with other Asian economies, including Japan," he said. "Measured by value added, our bilateral deficits with China would have been far less, and our bilateral deficits with other Asian exporters would have been far more."

Under the circumstances, a decision by the Chinese government to revalue its currency -- which is also known as the renminbi -- would merely "redirect trade within Asia." He added: "Some observers mistakenly believe that a marked increase in the value of the Chinese renminbi relative to the U.S. dollar would significantly increase manufacturing activity and jobs in the United States. I am aware of no credible evidence that supports such a conclusion."

Still, Mr. Greenspan said, China should move quickly to change its exchange rate system -- for its own good. To maintain that system, China has to purchase large amounts of foreign currencies and issue domestic-currency bonds to keep inflation from running out of control.

That task, he said, will become increasingly difficult for its central bank to perform. "Sterilization of continuing inflows of speculative funds will presumably become more difficult as the scale of these operations, already large, increases over time," Mr. Greenspan said.

It's better, he said, for China to let market forces regulate the currency because "financial markets, if left free to continually reprice interest rates and asset values, will identify and respond to imbalances far sooner than a system based on administrative edict."

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