Understanding the Sources of Friction in U.S.-China Trade Relations: The Exchange Rate Debate Diverts Attention Away from Optimum Adjustment

I am grateful to the Asian Economic Panel for insightful comments on an earlier draft; and to Gary Burtless for invaluable help compiling labor market data. 1 China has been accused exchange rate manipulation that has caused large U.S. trade deficits, which have reduced U.S. welfare by increasing unemployment and reducing wages. In fact, the strong claims by some observers that the trade imbalances are deeply deleterious to China's welfare almost make it a moral imperative for the United States to use tariffs to force an RMB appreciation for China’s own good. The truth, however, is that: • The claim that a 40 percent appreciation of the Renminbi (RMB) against the US $ would reduce the U.S. global trade deficit represents the triumph of hope over experience. When the average Yen-US $ exchange rate fell from 239 in 1985 to 128 in 1988, the U.S. global current account deficit only fell from 2.1 percent to 1.7 percent of GDP because Japanese companies started investing abroad and exported to the U.S. from there. For similar reasons