Health Care? Check – Now, What’s Next?

President Obama’s “all-or-nothing” health care gambit paid off with a victory in last Sunday’s vote. With that dragon finally slain, it’s time to get on with the next pressing issue – the economy.

With very weak growth projections and flat employment expected until well into 2011, President Obama faces increasing pressure to find a way to jump-start the economy. Much of this pressure is coming in the form of renewed demands to officially declare China a currency manipulator. This declaration is what some insiders see as the first step to implementing a series of punitive measures that supporters hope will narrow the trade gap with China.

Twice a year, the Treasury Department issues a report listing the countries that it believes engage in deliberate currency manipulation. So far during Obama’s tenure, two of these meetings have passed without China being named to the list, but calls are increasing in ferocity to change this for the next report due April 15th.

Given the state of the economy, it is understandable that some of these calls are coming from within the government itself. In an attempt to deflect criticism, it seems that politicians are on the lookout for a scapegoat to take the fall for the economy’s problems, and it appears that China is now the most likely candidate.

“The impact of China’s currency manipulation on the U.S. economy cannot be overstated,” read a letter forwarded to the Treasury Department last Monday and signed by 130 members of Congress. “Maintaining its currency at a devalued exchange rate provides a subsidy to Chinese companies and unfairly disadvantages foreign competitors.”

If you recall, shortly after taking office, the Obama administration did say that it believed that China was artificially maintaining a low currency, but nothing further came from this comment. For its part, China has denied all allegations, but actions speak louder than words, and the preponderance of evidence is squarely against China. It is estimated that China continues to buy $30 billion a month in foreign currencies and its total reserves are closing in on $2.5 trillion.

Buying foreign currencies in this manner serves two purposes – it increases the availability of yuan in the foreign exchange markets, while simultaneously sopping up the excess supply of the currencies in which it sells most of its products. This strategy has served China well in keeping the yuan devalued in relation to other currencies, and as its largest customer, the U.S. dollar has long been the prime target for China’s foreign currency acquisition program. This is seen by American authorities as direct evidence of currency manipulation.

Despite this more hawkish stance of late, there is still an underlying fear that China could sell its massive U.S. holdings in some form of retaliatory move. Certainly, selling even part of its considerable reserves would likely cause the dollar to fall, but there are two very good reasons why China would be unlikely to pursue this course of action.

Firstly, a sudden devaluation of the dollar would actually hurt China as much as the U.S. as China’s reserves would lose value with every down-tick in the dollar itself. This seems to be a tremendous price to pay simply to “punish” the U.S.

Secondly, should the value of the dollar plunge, exports from China would immediately cost more to American consumers. This would be catastrophic to China’s exporters and is the very thing that China has been trying to avoid for decades.

I think what we are seeing right now, is a push by U.S. lawmakers eagerly searching for a way to show the electorate that they have the best interests of the country as a priority. The health care debate was – in a word, ugly – and with the November primaries fast approaching, candidates are looking for a unifying cause upon which they can hang their hats.

The danger in my view, is that the increasing level of rhetoric could escalate into some form of protectionist action. In the current environment, it is not difficult to imagine the imposition of tariffs or other punitive measures all in the name of “saving jobs”. Ultimately, neither country is best served by backing each other into a corner just as the global economy is recovering from the worst recession since the 1930s.

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