Protectionism Won't Work Against the Yuan

The unfortunate decision by the Bush administration to impose countervailing import duties on coated paper imports from China did not pass without comment from yours truly in a Columnist Conversation posting. But, thought I, RealMoney readers deserve more than an unsubstantiated rant; Lord knows we have enough of that in today's world.

We need to step back and assess how the world has looked before and after China's decision to let the yuan start revaluing on July 21, 2005.

First, please note that I said "revalue" and not "float." The yuan is still a managed currency, not a freely floating one. If we index the yen and the euro back to July 2005, we see how both currencies rise and fall. I added vertical markers in May 2006 and February 2007 to note the two credit-tightening decisions by the Bank of Japan.

The yuan has appreciated 7.1% over that period, while the euro has appreciated 10.0% and the yen has depreciated 4.2%.

Comparative Currency Strength After Yuan Peg Loosened

Click here for larger image.

Source: Bloomberg

Is a managed currency synonymous with currency manipulation? No. Let's be candid: Ever since the 1971 Smithsonian Agreement broke fixed exchange rates, all countries have used currency manipulation as an instrument of national policy. The U.S. has been one of the worst offenders in this regard, particularly from 1985 to 1987, when the dollar was devalued deliberately in hopes of reducing the American trade deficit. How did that one work?

China's trade advantages derive only in small part from the yuan:

• Labor in China is cheaper and in many cases is thought to border on quasi-slavery.
• China's banks have ready access to the foreign exchange reserves of the People's Bank of China; think of this as the world's largest no-documentation loan.
• China's environmental regulations, worker safety protections and health care are nonexistent by standards prevailing elsewhere in the industrial world.
• Because China has newer plants and equipment, it enjoys the benefits of the latest technology.
• American class-action lawyers would be handed a blindfold and a cigarette if they tried to operate in China as they do in the U.S., and the country's abuses of global intellectual property are legion.

And we are worried about the yuan giving China an advantage? Get serious; a 5% or 10% revaluation would not even scratch the paint on China's trade advantage.

It would, however, represent a direct tax on the American buyers of those goods with absolutely no assurance it would result in a restoration of American competitiveness, for the reasons enumerated above.

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Howard L. Simons is president of Simons Research, a strategist for Bianco Research, a trading consultant and the author of The Dynamic Option Selection System. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. While Simons cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.

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