It was important for Treasury Secretary-designate to flatly state that China is manipulating its currency. Everyone knows China’s currency is being held at an artificially low level, and it is necessary for the United States Government to acknowledge this in order to be able to approach the problem realistically. (See New York Times and WSJ stories.)

The next step is more difficult – how to get China’s currency appreciating again. The currency appreciated 21 percent against the dollar through July 2008 and then went flat as Chinese authorities decided they were concerned about China’s slipping export performance in the slowing world economy. The fact of the matter is that China’s continued currency manipulation is hurting their own economy and making their transition away from export-led growth more difficult. Yuan appreciation can be win-win.

The Treasury Secretary-Designate is properly concerned with China’s currency and as the next step needs to work within established international means to find a solution. During the campaign, then-candidate Obama saw the importance of a change in China’s currency practices and said he would use all the diplomatic avenues available to seek such a change. Certainly the International Monetary Fund can play a stronger role than it has in the past.

Geithner’s statements showed he wants to get China’s currency moving, but without precipitating a new global financial crisis. Global financial stability and further appreciation of China’s currency can and should go hand in hand, but all this needs to be done carefully and in a way calculated to achieve both objectives and contribute to a lessening of global imbalances.

The yuan per dollar graph below shows how China’s currency was moving until July 2008, and then was held flat.

The United States has learned its historical lessons and will avoid going down the path of the depression-deepening Smoot-Hawley and protectionism as it counters the current recession. Surely it has.

But given the new global economy, more integrated and competitive than in the 1930s, the United States is not the sole determiner of economic policies. Maybe this time around, it’s China that makes the mistake of enacting its version of Smoot-Hawley, a foolish, domestically targeted policy that sparks a trade war.

From Reuters, “Yuan drop extremely disturbing“:

WASHINGTON, Dec 4 (Reuters) – A sudden drop this week in the value of the Chinese yuan <CNY=CFXS> could reignite political tensions over the huge U.S. trade deficit with China, U.S. business groups said on Thursday.

“This is extremely disturbing,” Frank Vargo, vice president for international economic affairs at the National Association of Manufacturers, told Reuters as U.S. Treasury Secretary Henry Paulson and other senior Bush administration officials were in Beijing for high-level economic talks.

The yuan’s drop came just days before that meeting and just a little more than one month before President-elect Barack Obama takes over in the White House.

This news comes just as the fifth U.S.-China Strategic Economic Dialogue wrapped up. Secretary Paulson did not address the issue in his formal closing remarks, saying later that China remains “committed” to continued appreciation of the currency. And trade is not ONLY currency.

From Paulson’s closing statement:

As in the past, we discussed the importance of domestic-led growth, and the importance of a market-determined currency in promoting balanced growth in China that will contribute to a healthy global economy. I welcome the steps announced by the Chinese to further open their financial markets, such as allowing foreign banks to trade bonds on the same terms as Chinese banks. Strong financial markets will enable healthy economic development across China. (continue reading…)

A Financial Times story about a study that predicted China overtaking the United States as the world’s top manufacturers drew a fair amount of attention last week. Unfortunately, it misstated the views of NAM’s President  and CEO John Engler, who writes a corrective column that appears in the Monday edition.

From “American industry can stay ahead of China“:

According to a report last week in the Financial Times, China is now reverting to form as the world’s workshop and will overtake the US as the world’s largest manufacturer next year. I and members of the National Association of Manufacturers strongly disagree with this prediction.

China has a long way to go to catch up with the US. The NAM’s analysis shows that in terms of real manufacturing value-added (price-adjusted, to reflect the quantity of output) the US remains by far the world’s largest manufacturer, producing nearly one-fourth of the world’s industrial output. Based on the highly respected World Bank database, our analysis also shows that we will produce twice as much this year as the fourth placed economy, China (the European Union and Japan are in second and third position, respectively). Even in current measures of manufacturing denominated in dollars (which inflate China’s position because of the rising yuan and other factors), China will produce only about 60 per cent as much as the US in 2008.

Far from overtaking the US next year, if China were to be able to continue its rapid 10 per cent-plus real annual rate of manufacturing growth, it would not equal US manufacturing production until nearly 2020. Moreover, given the constraints China is beginning to face, its ability to maintain that torrid growth is highly questionable.

Let me be clear. The only way China could surpass US manufacturing next year would be for the US to encounter an economic catastrophe of some kind. That would not be wholesome for us or anyone. It is possible – but not certain – that China may, in some future decade, become the world’s largest manufacturer. If this occurred because the Chinese economy moved away from export-led growth and began to see the type of domestic-led growth that Hank Paulson, the US Treasury secretary, has been trying to get them to adopt, this could elevate China’s living standard and create more demand for all goods and services in China – including imports from the US and the rest of the world. That would be a positive contribution to the global economy.

Here is the correction:

Today’s Washington Times features a front-page story, “‘Made in USA’ starts to make a return,” covering the return to the United States of manufacturing facilities driven by high transportation costs and exchange rates, including appreciation of the Chinese yuan:

“The days are over where you just think you can go over to China to get something cheap,” said Harry Kazazian, chief executive officer of Exxel Outdoors Inc., a Haleyville, Ala., producer of outdoor recreational gear.

Exxel has been doing just that since 2005, when executives detected the beginnings of a market shift favoring homemade wares.

“It’s kind of like the light bulb goes off in your head,” Mr. Kazazian said.

“We really need to come back,” he told Exxel President Armen Kouleyan while they toured their production plants in China.

Other companies cited as examples are Firestone and Artco-Bell Corp. of Temple, Texas. The NAM’s Hank Cox and David Huether are also quoted.

Good look at an issue that’s getting more attention lately.