The House has just passed a bill that would allow the President to impose tariffs on China in retaliation for China's currency manipulation. Although the traditional defenders of the currency status quo have been predictably shrill in their reaction to this "protectionism," cooler heads realize that the bill means nothing. The Senate is not going to pass the bill soon (and most likely never), and even if it passed, the bill only gives Obama permission to impose tariffs; remember, Obama has passed up the opportunity even to label China a currency manipulator. Chinese officials, for their part, are not overly concerned. Nor should they be: America is not going to get tough with China anytime soon.
The reason America is not going to get tough with China anytime soon is actually pretty interesting, since it involves a unique confluence of factors. Both of the two main political blocs in America want to avoid doing anything about China's currency manipulation, but for very different reasons.
For Republicans, it is because China is making them rich. In addition to a massive supply of cheap labor, China offers American business owners low costs via lax protection of property rights and the environment. Here's how it works: When a businessman in China wants to build a factory, he gives a kickback to a local official, who allows him to dump toxic waste in the river and kick as many peasants off their land as he wants. That allows the Chinese businessman to provide goods to U.S. multinationals at extremely low cost, boosting U.S. profits and forcing down the wages of U.S. workers. Naturally, these effects are exaggerated hugely by the undervalued yuan.
In other words, China has given America's capitalist class what they have long dreamed of: in the words of Hyman Roth from The Godfather Part II, "a real partnership with [a] government." This gravy train is probably the main reason why capital's share of income in the U.S. has reached record highs (and labor's share record lows). Note that the same has happened in China.
But there's more. China's currency manipulation requires that China's government buy lots and lots of U.S. debt. That lowers interest rates in the U.S., which in turn allows U.S. finance companies to borrow lots of money very cheaply, thus boosting their profits (which reached 45% of all U.S. profits in the early '00s). Although many contend that these artificially low rates were a big cause of the recent bubble and financial crisis, finance companies - who, despite what the Tea Partiers would have you believe, are big supporters of the Republicans - continue to depend indirectly on Chinese financing for their yearly bonuses.
But what about liberals? You'd think that soaring inequality and collapsing middle-class wages would have Democrats thundering for retaliatory tariffs, but no; for reasons all their own, liberals don't want to get tough on China either. Many, such as Brad DeLong and Matt Yglesias, fear that trying to force China to change its ways will start a new Cold War. That is something they really don't want. The first Cold War was a (temporary) disaster for liberalism - it boosted the power and importance of the U.S. military, encouraged red-baiting, and led to wars. A decades-long standoff with China might well tip U.S. culture back toward militarism. As a result, though Democrats have been perfectly willing to scuttle trade deals with small, weak countries like South Korea or the countries of Central America, China's great-power muscle has proven overwhelmingly intimidating.
Thus, although a few prominent figures (Paul Krugman among them) have urged the U.S. to take a harder line toward China, the bipartisan consensus is still overwhelmingly against taking any sort of action that would anger the Chinese. And the People's Republic, for its part, is prevented by its own domestic politics from correcting a currency policy that might soon cause dangerous imbalances. So the world's two superpowers will remain locked in an unhealthy, co-dependent embrace, until things get so bad that they force one or the other country to act. By then, of course, the cost of action will be much higher.
Update: Paul Krugman suggests that irrational fear of "protectionism," indoctrinated into Americans since the disastrous Smoot-Hawley tariffs, is a big factor in scaring Americans into not doing anything about Chinese mercantilism. A friend suggested this to me. I'm not sure how big a role ingrained fear of "protectionism" plays in all this, but my point is that irrational fear isn't necessary to explain why America refuses to resist Chinese mercantilism. Most people are simply too leery of the consequences (higher production costs, higher interest rates, and worsened U.S.-China relations) that resistance would entail. The mercantilism problem, big as it is, isn't yet big enough to spur people to action.
Update: More from Krugman, who is pretty angry about the situation:
So, why did Tim Geithner feel the need to declare,
We’re not going to have a trade war; we’re not going to have currency wars. I don’t know what that means, but people are saying that.
I suspect that he was trying to reassure the markets — but if we’ve learned anything lately, I hope it is that actions, not talk, matter.
And look, if China continues on its present course, eventually we will have some serious currency and trade conflict. Furthermore, we should.
All Geithner did here was signal to the Chinese not to worry, U.S. officials will keep making excuses for China’s behavior and doing nothing, regardless of provocation. Remember, this statement comes after China blatantly reneged on earlier promises about the exchange rate. They must take us for fools — because we (or at least some of us) are.