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Originally published Wednesday, May 25, 2005 at 12:00 AM

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Guest columnist

Keeping the train rolling in China's Kaching! Dynasty

Bullying China over exchange rates isn't going to work. Congress has its knickers in a twist because the home folks are losing manufacturing...

Special to The Times

SHANGHAI — Bullying China over exchange rates isn't going to work.

Congress has its knickers in a twist because the home folks are losing manufacturing jobs to cheap imports from China (Wal-Mart gets 80 percent of its goods from China), and is threatening tariffs on Chinese goods if something isn't done.

Meanwhile, the Bush administration dithers because China isn't Iraq so its "straighten up or we'll bomb you" approach to foreign policy is rendered inoperative. That leaves the occasional tragic but loyal soldier, such as Treasury Secretary John Snow, in the unenviable position of trying to simultaneously stall Congress and the legions of yes men who people the current administration.

But even Snow is now saying China must do something "significant" about exchange rates, or else.

However, even if we could get China to raise the value of the yuan relative to the dollar, it wouldn't bail out our economy. The change would be marginal at best, as 70 to 80 percent of our economy is not trade-related and China represents only 10 percent of our trade deficit.

First, some background: To buy goods from another country, you need that country's currency. So we need a lot of yuan to buy all that stuff from China. Some of it we get from goods we sell to the Chinese, who pay us back in dollars. But as we buy more from them than they buy from us, we have to get yuan from elsewhere. In essence, we borrow them.

That has left China holding $650 billion in U.S. government notes, which would be bad for us if the Chinese decided to get rid of them. It would make the value of the dollar fall even further and raise long-term interest rates at home, hurt the housing market and cause a recession. It's not a likely scenario, but it's worth thinking about.

What the U.S. and a lot of countries want China to do is to free up the yuan, currently fixed at 8.27 to the dollar. If it floated, the worldwide demand for yuan would drive up its value relative to other currencies, making Chinese goods more expensive and helping to address the trade imbalance. It would also make our goods cheaper in China.

China doesn't want to do this, for two reasons, stated and unstated.

The stated reason is that China's banking system is still reeling from 40 years of socialist mismanagement. China's four biggest and still state-run banks have bad-debt loads ranging from 19 to 42 percent of their total loan portfolios. By Western measures, they're on life support. China fears a banking collapse if the currency is allowed to float and interest rates fall as the value of the yuan rises.

That leads to the second reason, which the Chinese don't talk about, except when some official says "China is a developing country," which I hear a lot.

China is like a freight train running full speed on only one rail, and the question is: Does it manage to land the other set of wheels on the second rail, or does it tip the other way and tumble off the track?

While official reports continue to say the economy is growing at close to 10 percent a year, even if that's true, it won't last forever. And the success of what I like to call the Kaching! Dynasty is entirely predicated on rising living standards for most of the nation's 1.3 billion people.

In the 1980s and 1990s, when the counterpoints were the twin disasters of the Great Leap Forward and the Cultural Revolution, that was easy. Farm economies rose (still 75 percent of the people) and the cities turned around and began to boom. Shanghai is like Seattle on steroids and a triple grande mocha through an IV.

But the farm economy is a little stagnant because — surprise! — rising productivity means you need fewer farmers. So Shanghai and other big towns are steadily filling up with unskilled workers from the rural west who make a living at such highly paid tasks as mopping the sidewalks (without much effect) or handing out advertising fliers for cellphones.

The Chinese leadership understand that whatever happens, they have to keep the train moving or face renewed unrest, which happens here more than you might think. So anything that threatens exports and hence jobs, like a more expensive yuan, is problematic.

The possible scenarios are unrest and state crackdowns, which means human suffering; or the government collapses, which means American firms that have invested in China lose a lot of money; or forces within the government end China's current experiment in "socialism with Chinese characteristics" (which you and I call capitalism) and we lose money as China's economy shrinks. Any of these scenarios is bad for both China and the U.S.

Or let's say we slap some tariffs on those cheap Chinese goods. You think they won't retaliate? How many jets will China buy then? How many Washington apples (which I can now find here in any market)?

But beyond that, this is China, and what any conscious ex-pat will tell you is that if you threaten or bully a Chinese person, he will dig his heels in and you'll get nothing.

So what the United States needs is not threats, but coherent foreign and economic policy. You want something from the Chinese? Coddle them, flatter them, coax them — I've never been in a country so desperate to be recognized as a player, as they say on the street back home. They won't be bullied; they can be convinced.

The list of economic steps we might take is long; doing something about the budget deficit and something meaningful for displaced workers would only start the list. And how about making it easier for all the Chinese scientists and engineers who want to come to America to get visas?

But what we have, at the moment, is a Bush in a China shop, and what he breaks, we get to pay for.

T.M. Sell is professor of political economy at Highline Community College and currently a visiting professor at Shanghai Jiao Tong University.

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