Are US protectionist threats about to become reality?

published 12 April 2007

The label on the photograph sent a chill down my spine: "Reed Smoot, Republican of Utah, Senate Finance Committee Chairman, 1923-33." Along with photos of other past chairmen, it was hung in the anteroom to the Senate Finance hearing chamber. The formal high-collared pose of the dapper mustachioed senator was the last thing I saw before I entered the hearing room on 28 March to testify on US-China currency policy before the Senate Finance Committee. The legislator from Utah was, of course, the co-sponsor of the notorious Smoot-Hawley Tariff Act of 1930 a policy blunder of monumental proportions that played a key role in sparking a global trade war and the Great Depression. Some 77 years later, his spirit was very much in evidence as the Senate Finance Committee gathered to debate the "China threat."

Protectionism now has bipartisan support

Over the years, I have participated in several congressional hearings on US-China economic relationships. Just six weeks ago, I testified on this same issue in executive session in front of the Subcommittee on Trade of the US House Ways and Means Committee. This latest hearing in front of the all-powerful Senate Finance Committee was different. I left the Dirksen Senate Office Building convinced that trade sanctions against China are now inevitable. Support is deep and bipartisan. And the experts tell me that the margin of support appears broad enough to be veto-proof in the event that President Bush objects. After years of talk and bluster, protectionism no longer seems like an empty threat. This time, it looks like the real thing. I suspect a protectionist trade or currency bill could become law by year-end 2007.

This conclusion quickly became evident in the opening minutes of the hearing. An ominous and well-coordinated warning was delivered by two of America's leading China bashers Senators Chuck Schumer (Democrat from New York) and Lindsey Graham (Republican from South Carolina). Their bipartisan teamwork over the past five years has been key in elevating the China debate in the US Congress. They were the co-sponsors of the infamous bill that would have imposed a 27.5% tariff on China as a penalty for maintaining a currency that they believe was undervalued by a like amount. Senator Schumer now admits this proposal was nothing more than a stalking horse to galvanize support from his fellow senators. In his words, "We never intended the original bill to become law. It was a shot across the bow." Yet both he and Graham admit to being stunned when 67 senators voted to support their measure on a procedural action in 2005.

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Emboldened by that response and empowered by the results of last November's mid-term elections, Schumer and Graham have now embarked on a far more serious course of action. They have joined forces with Senators Max Baucus (Democrat from Montana and Chairman of the Senate Finance Committee) and Charles Grassley (Republican from Iowa and ranking minority member on Senate Finance) with a united pledge to present a new China currency bill by midyear. Unlike the tariff bill, which the senators now admit was not "WTO compliant," they have promised to make their new proposal fully compliant with WTO rules and provisions. The Senate Finance Committee hearings of March 27-28 were the first step in what I believe will be a methodical and very deliberate legislative process. In the end, Senator Graham said it all: "We are in the middle of a defining moment right now. This is one issue where Republicans and Democrats are together, and we are going to act." I'm afraid it doesn't get any clearer than that.

There were four of us on the panel of so-called expert witnesses that followed Senators Schumer and Graham myself, Cornell Professor Eswar Prasad, Morris Goldstein of the Petersen Institute, and John Makin of the American Enterprise Institute. I went first and was quick to criticize the Schumer-Graham approach. The others, however, were far more sympathetic to the anti-China sentiment expressed by the senators. My comments essentially rang hollow in this two-hour hearing.

I attempted to make three basic points: One, America's extraordinary saving shortfall sets us up for chronic trade deficits with China and a host of our other trading partners. Two, China is focused on a major rebalancing of its own economy that, over time, will provide structural relief to its trade surplus. And three, America's middle-class angst which is driving the politics of China bashing reflects a US economy that failed to prepare its workforce for the pressures of an IT-enabled globalization. There was little or no response to anything I said.

Don't get me wrong. I am not nave enough to believe that my arguments would bring the senators to their senses and turn this debate on a dime. After all, this is politics not analytics. But I took the opportunity to underscore what I believe are several serious inconsistencies in the very structure of the China debate. I reminded the senators that by boring in on the currency angle, they were framing the debate on the relative price between two nations an approach that needed to consider strengths and weaknesses of both the US and China. Yet, apart from my testimony, no one made the slightest mention of America's saving problem and the key role it plays in driving current account and trade deficits. I also warned of the hypocrisy of the "asymmetrical phasing" implicit in the Congressional fix putting pressure on the Chinese to move immediately on the currency front while allowing the United States ample time to address its saving shortfall. I concluded by asking the senators if they really thought that an adjustment in the bilateral exchange rate between the US and China would improve America's saving position, redress US income disparities, or accelerate the pace of structural change in China? My answer was "no" on all three counts. The senators never even answered the questions.

Over the past two years, 27 separate pieces of anti-China legislation were introduced in the 109th Congress. None of them passed. This year, it's likely to be different. In just the first three months of the 110th Congress, at least another dozen such actions have been introduced. But the big one has yet to come. Senators Baucus, Grassley, Schumer, and Graham are about to swing into joint action and come up with what I believe will be a very serious piece of WTO-compliant legislation. Despite the political acrimony that pervades Washington these days, these four senators are united on this one issue as are most of their colleagues in the upper chamber of the US legislature. Chairman Baucus closed the hearing with a very clear statement on where the four-senator collation is headed on the China currency bill over the next couple of months. In his words, "We want to do it right. We want to be effective. We want to be firm. And we want to act."

Sadly, I am not all that surprised by this turn of events. I have been warning of a rising backlash against globalization for the past couple of years, and now the moment of truth finally seems to be at hand. Ironically, this is all playing out when the US unemployment rate is hovering near its cycle low of 4.5%. Yet with downside risks to the economy building by the day, the jobless rate has nowhere to go but up a development that will only further inflame the bipartisan politics of trade protectionism.

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