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Fight the Dragon
China is waging war on free trade.

(Imaginechina via AP Images)

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The issue of currency manipulation has become a symbolic flashpoint in policy debates not because it is the most serious of the Chinese abuses but because it is the most obvious instance of America’s failure to take Chinese abuses seriously.

Almost no one disputes that China manipulates its currency. The U.S.–China Economic and Security Review Commission, a federal body established by Congress to monitor the economic relations between the two nations, stated plainly in its last annual report that “China continues to manipulate the value of its currency, the RMB, to achieve a competitive advantage with the United States.” In its semi-annual report on currency manipulation, released in April, the Treasury Department declared China’s currency “significantly undervalued” and noted “continued [Chinese] actions to impede market determination.” Chinese policy appeared to be worsening, and “recent developments,” it said, “raise particularly serious concerns.”

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But as in every other report of the past two decades, the Treasury Department refused to call a spade a spade and officially designate China as a currency manipulator, for fear of offending the Chinese. Therein lies the root of the problem. Even as China thumbs its nose at the international trading system and surges forward economically at U.S. expense, the consensus remains that the United States should do nothing to respond lest it provoke China’s ire. The situation is so sensitive, evidently, that even taking the extraordinarily tepid step of assigning the (entirely accurate) label of “currency manipulator” could trigger a painful response. And yet, if China knows that it will face no consequences for even its most blatant and undeniable abuses, who can blame it for taking an ever more aggressive approach?

China has found itself an ideal arrangement, in which it betrays while the United States cooperates. It has calculated — correctly, so far — that faced with this betrayal the United States will opt to continue its cooperation anyway rather than risk open economic conflict. But this arrangement is not sustainable. The international trading system is not self-enforcing; it is a reciprocal construct in which only the prospect of benefits denied compels each nation to operate within the rules in a manner that can make all nations better off. If the threat of retaliation is not credible — if large economies so fear the possibility of a trade war that they would rather simply surrender — then more and more countries will flout the rules more and more aggressively and the system will unwind.

This dynamic is not unique to the economic sphere. It is the same one that plays out in potential military conflicts, where a credible willingness to meet force with force is critical to deterring aggression in the first place. As long as nations prefer peace to war, the peace is kept. But if Nation A believes it can choose force that will be met not with force but with complacence, using such force suddenly becomes the most attractive option. It is in this moment, when Nation A chooses force, that Nation B must decide whether to fight back.

There are always those calling on B to tolerate the provocation as preferable to open conflict. The word for such an approach is “appeasement.” In the military context conservatives generally reject it, recognize that removing the consequences for aggression only invites further aggression, and argue for imperiling American lives in defense of the national interest. Yet somehow, when the topic turns to trade and it is a quarterly profit statement potentially imperiled, bold declarations of “peace through strength” turn into squeamish equivocations about the need for dialogue.

Perhaps once upon a time, when China’s economy was small, its violations were a mere inconvenience unworthy of response. But that time has long since passed. China’s strategy is causing severe, permanent damage to the U.S. economic interest, and the United States needs to make clear that, faced with such misconduct, its choice will be retaliation rather than tolerance. China will then need to decide whether to return to a peaceful equilibrium in which all sides play by the rules or to continue down its current path and destroy its economic relationship with the United States.

Given only those two options, following the rules would seem the obviously more attractive one for all involved. That is the hope and the goal — not actually to retaliate but rather to create conditions under which betrayal is no longer contemplated by either side. But the crucial point is that if China does in fact prefer an open trade war to genuine free trade, then collapse of the economic relationship is inevitable. With a country that prefers a trade war to free trade, the United States has no better hope of maintaining a beneficial relationship than it has of keeping the peace with a country that prefers war to remaining within its own borders.

The typical condemnation of such an approach as “starting a trade war” represents a nonsensical form of economic pacifism. The trade war has already started, but only one side is fighting. The question for the United States is whether to respond or surrender, bearing in mind that a response has a good chance of defusing the conflict, whereas a surrender will only embolden nations with no commitment to free markets, undermine the health of the trading system as a whole, and leave the committed free-traders to fight on far less favorable ground at some point in the future.

If America will not respond to the current abuses, when will it respond? When China’s economy is dramatically larger, less reliant on exports, and supported by robust alliances with other mercantilist nations? When China announces it will no longer purchase American drugs and will instead manufacture its own versions locally? When the first Chinese commercial airliner rolls out of the hangar, looking suspiciously similar to Boeing’s latest model but available at half the price?

The United States needs a comprehensive arsenal of retaliatory economic weapons that it can credibly threaten to use if China (and, in the future, any other nation) does not quickly and sharply alter its course. Some of these weapons it can develop and deploy unilaterally. Others will rely on coordinated action among developed economies to achieve the desired effect without disadvantaging U.S. producers. All should be designed as ratchets that can apply increasing pressure — the goal, after all, is not to actually use any of them or to do damage but only to make clear to the Chinese that the threats of such action are credible.

UNILATERAL U.S. ACTION


The United States should create structures that enable broad-based retaliatory actions against the government subsidies and intellectual-property theft embedded in Chinese exports, while also applying maximum pressure at discrete points where it has the most leverage. The best leverage point is America’s higher-education system, access to which is desperately coveted by the Chinese and is a critical ingredient to their technological advancement and economic development. More than 200,000 Chinese nationals studied at American universities last year, representing more than 25 percent of all foreign students (though only about 1 percent of total enrollment). None of these students need be expelled, but visas for new entrants should be sharply curtailed and ultimately cut off. Such a move would pose no threat to America’s academic preeminence, but it would badly damage China’s human-capital development and focus the injury directly on the Chinese elite with the most leverage over their nation’s policy.



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