China Bill: Huff, Puff and Bluff

US national elections are 13 months away and not coincidentally, the Congress is looking at a new measures to encourage China to re-value the yuan. While there is little doubt that the yuan in under-valued, though reasonable people may differ on the magnitude, politics more than economics appears to be the driving force.

The most important threats to US prosperity lies within its borders. The de-leveraging of the household sector, the continued depression in the housing market, and extreme divergence between wages and salaries on one hand and profits on the other hand are not the result of the misalignment in the currency markets.

However, that message may not resonate with American voters as much as much as blaming China. Even Federal Reserve Chairman Bernanke yesterday said that China's under-valued yuan was damaging prospects for the global recovery.

This is not the first time such a measure is being considered. It seeks to shift the focus from current legislation that is about countries that manipulate their currencies for trade advantage to misalignment of currencies. The bill would make it easier for US businesses to seek redress from countries that have misaligned currencies.

The bill's prospects are better in the Senate than the House of Representatives, especially after the amendment that from Senate Republicans to prevent unilateral US action, by working with the WTO and IMF. However, Speaker of the House of Representatives Boehner has called the bill "pretty dangerous" and it is possible that the Republican controlled House does not even bring it up for a vote.

Ironically, it seems that although the House and Senate appear largely, but not exclusively, divided along party lines on the issue, the Democrat Administration does not appear particularly supportive, though has tried to maintain neutrality. Yet, Obama has been criticized for being "soft" on China following his decision not to sell Taiwan new F16 fighter planes.

It is bad economics in the sense that it exaggerates the role of China. For example, the San Francisco Fed recent study found only 2.7% of US consumer purchases are made in China. Of that figure, a little less than half represents China-produced content.

A little less than 90% of US consumer spending is on things made in the US. The only area in which China appears to be more important than domestic businesses is in the nondurable goods category for things like clothing and shoes (China accounted for a little more than a third of the US market). It also does well in electronics and household appliances.

In 2010, US imports accounted for about 16% of GDP. Imports from China were worth about 2.5% of GDP. Looking at personal consumption expenditures, foreign made goods accounted for about 11.5% and China about a quarter of this. And even this 11.5% exaggerates the cost of the foreign good. The San Fran Fed found that of that 11.5%, only 7.3 percentage points were accounted for by the cost of imports and the remaining 4.2% goes to transportation and wholesale and retail activity.

Of the 2.7% of US consumer spending on goods made in China, less than half (1.2 percentage points) is on the imported good. What this means is that "...on average, of every dollar spent on an item labeled "Made in China" 55 cents goes to services produced in the United States", according to the San Fran Fed report.

The researchers use the iPhone as an example. In 2009, it cost about $179 in China to produce and sold in the US for about $500. "Thus $179 of the retail cost consisted of Chinese imported content. However, only $6.5 was actually due to assembly costs in China. The other $172.50 reflected costs of parts produced in other countries, including $10.75 for parts made in the US.

Lastly, it is interesting to note that the Chinese yuan has been the strongest emerging market currency over the past year, appreciating nearly 5% against the US dollar. It has almost been the strongest emerging market currency over the past five years, appreciating about 24% against the US dollar. In terms of G10 currencies, only the Japanese yen, Swiss franc and Australian dollar have appreciated more than the yuan against the greenback.