Free Trade: Under Siege

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"It's going to be the perfect storm" is how one knowledgeable Capitol Hill insider described the upcoming efforts by protectionists of both parties in Congress to pass trade legislation punishing China for running a $200 billion-plus trade surplus with the United States. This week's high-level "strategic dialogue" between a Chinese trade delegation and American officials from the White House and Congress did nothing to change that assessment. There's too much momentum behind the push, the insider told me, from members who worry about the economic impact of a weak Chinese currency and from those who fret about China as a potential military threat.

Indeed, the trade meetings were barely over when a Senate committee started considering a measure to allow companies to petition for new duties on Chinese products. Meanwhile, Rep. Charles Rangel, chairman of the House Ways and Means Committee, said his committee will look at a similar measure.

But the protectionist wave sweeping through Congress is not likely to stop there. Analysis from Goldman Sachs, the former corporate home of Treasury Secretary Hank Paulson, thinks the House will most likely pass legislation in June that would allow duties to be applied to Chinese goods. Similar legislation will be introduced in the Senate that will at the very least force the Treasury Department to label the Chinese currency as "misaligned" and lead to further action.

There is little chance that China would permit the sort of rapid currency appreciation that would satisfy Congress. A perusal of official Chinese newspapers reveals a country fixated on the example of Japan, which, at U.S. urging, allowed its currency to appreciate dramatically. Not only did the strong yen worsen Japan's economic slump in the 1990s, but its trade deficit with the United States didn't improve.

The endgame here may be the passage of legislation that would assess an across-the-board tariff of 20 percent on Chinese goods. (A similar bill has been proposed in the past, but the GOP leadership quashed it.) My source believes such a bill would pass today with vetoproof majorities.

Such a legislative move would stun Wall Street, where markets rallied recently after Congress and the White House came to an agreement to attach environmental and worker protections to several pending trade agreements. Protectionism has been the biggest fear of many investors, who may be underestimating the risk of trade war with China, for surely China would respond–perhaps canceling Boeing airplane orders or even dumping U.S. treasury bonds–in any such a scenario.

An analysis by investment firm Morgan Stanley found that its "market strategists unanimously concur that an outbreak of protectionism is not being discounted by any major asset class in world financial markets. ... These risks are being dismissed not just because they have been a bad bet in the past several years but also because of the deeply held perception that the United States ultimately does the 'right thing.' ... If a protectionist endgame starts to become more apparent, most major asset classes–equities, bonds, credit, and currencies–would be highly vulnerable as a result."

international trade

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