Last week, the House Ways and Means Committee approved a bill aimed at addressing China's currency practices. It is scheduled for a vote by the full House sometime this week. In hearings, Committee Chairman Sander Levin (D-MI) stated, "the status quo with currency imbalances is unacceptable and unsustainable." He argued that China's "mercantilist policies" distort trade and slow U.S. economic growth and job creation.

Levin had listed a number of potential policy responses. None of the remedies promise quick or significant relief to America's jobs deficit. A number of them risk serious side effects. The committee settled on one which may be more symbolic than potent. The bill seeks to increase the chances for American businesses to win tariff protection by treating China's currency policy as an illicit subsidy. The bill was watered down significantly so it would not run afoul of global trading rules.

The fundamental problem is a disconnect between U.S. policymakers' sense of what global rules of economic conduct ought to say and what they actually say. Two prominent examples of this disconnect can be found in the rules of the World Trade Organization: An agreement on subsidies and countervailing measures establishes the conditions under which a nation can retaliate against a trading partner's export-encouraging practices; Another specific provision -- Article XV -- says that exchange rate manipulation should not be used to frustrate the intent of the trade agreement.

These provisions form the basis of some of the most prominent U.S. plans for action against China. This week's House bill would let U.S. firms seek tariff protection from Chinese goods "subsidized" by an undervalued exchange rate. A WTO case on Article XV would take China to task for the trade distortions resulting from a misaligned exchange rate.

But the WTO does not allow retaliation against any and all subsidies. It sets some strict conditions on which ones are actionable. According to veteran international trade lawyers, there is serious doubt that a distorted currency would meet those conditions. Nor does Article XV offer much clarity about lines that cannot be crossed. In each case, there is an important gap between the rules as they stand and the rules as envisioned by China's U.S. critics.

With such a disconnect, there are three options. The United States government could pretend global rules read more favorably; it could ignore the rules and strike out, perhaps by imposing a broad unilateral tariff; or it could seek to modify the rules through negotiation. The first approach risks the appearance of flouting international agreements and sparking new trade conflicts. The second approach would leave no doubt about U.S. contempt for global accords and would risk destroying the rules-based multilateral trading system.

The remaining option, then, is to seek new agreement on proper international economic behavior. Fortunately, the groundwork for such an agreement is already in place. The Group of 20 leaders, meeting in Pittsburgh last year, endorsed a framework for "Strong, Sustainable, and Balanced Growth." Earlier this month, John Lipsky of the International Monetary Fund said in a speech that, while there had been substantial "buy-in" to the idea of rebalancing, the plans that had been put forward to date fell short of what was needed.

While discussions of the principles undergirding the global economic system should be inclusive, the implementation problems are really the concern of a small number of large countries. This suggests a new solution. A G-20 Implementation Subgroup, consisting of the United States, Japan, China, and Germany, would be well-positioned to craft a more serious program than we have seen to date. Representatives of the European Central Bank and the IMF could also attend, given those institutions' relevant roles.

This should not be a meeting to talk down the dollar, nor to vent criticisms of China. Rather, the Subgroup would have a mandate to discuss the broad range of macroeconomic policies needed to achieve the kind of global rebalancing that meetings of the full G-20 have already endorsed. This would certainly include ways for China to address its unhealthy global surplus, but it would also include discussion of deficit reduction measures to reduce U.S. borrowing. If the subgroup meeting were held in January, it could take into account the recommendations of the U.S. bipartisan deficit reduction commission.

This approach has the virtue of engaging the key players in a multilateral discussion in a group sufficiently small that it might reach agreement on action. The multilateral approach is preferable to unilateral or bilateral pressure both in that the underlying problem is multilateral and in its avoidance of the kind of national rivalries that can emerge in bilateral discussions.

There are obvious potential pitfalls to such an approach. There could be a complete failure to reach agreement, for example. These are deep-seated problems that run up against serious domestic concerns. Or there could be ill-advised attempts at a quick fix, as some have characterized a previous effort at coordinated action, the 1985 Plaza Accord.

But the other options on the palette are unpalatable. There is a broad sense among U.S. policy folk (and some abroad) that bounds of proper international economic behavior have been crossed. The problem is that those bounds are not spelled out anywhere. This mix of ambiguity and discontent seems like a recipe for serious conflict. A meeting with a pre-set mandate to address imbalances would offer the best opportunity to defuse some of those festering tensions.

The administration has decided that promoting economic development around the world is essential. Foreign assistance is a crucial part of how the United States relates to the developing world and plays a critical role in U.S. national security policy. To date, however, U.S. programs have not been as effective as they ought to have been. Aid flows through too many channels and there is poor overall coordination among the relevant agencies scattered through the government. It is time for this to change.

The preceding paragraph was pretty easy to write, since those were key themes of Secretary of State Condoleezza Rice in 2006. The paragraph works equally well this week, as the Obama administration unveils its own approaches. I'm well-versed in the earlier version, since I had the privilege of working on those issues as a member of her policy planning staff. After an extensive review of foreign assistance programs and countless intra- and interagency discussions about how the sprawling aid apparatus might be improved, Secretary Rice implemented a series of reforms, most prominently featuring tighter integration between the U.S. Agency for International Development (USAID) and the State Department.

Skip forward four years. After not one, but two extensive and concurrent reviews, the Obama administration is poised to tackle the same problems. It is doing so in the context of a United Nations discussion of the (limited) progress that has been made toward the Millennium Development Goals. Herewith, some places to look for potential changes.

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What was the administration trying to achieve by sending Larry Summers to Beijing? What message was it trying to convey? And was the intended audience American or Chinese?

Taken at face value, Dr. Summers, as head of the National Economic Council, was there to deliver a message about American economic concerns. Foremost among these has been the stubborn stasis in China's exchange rate against the dollar. If this was the real purpose of his trip, he achieved little; the Chinese did not even pretend to accommodate. According to the Wall Street Journal:

Chinese officials have consistently said that they won't change key economic policies because of foreign pressure, and argued that the exchange rate has little bearing on the U.S. trade imbalance with China. "Our exchange rate reform can't be pressed ahead under external pressure," Foreign Ministry spokeswoman Jiang Yu said at a regular press briefing Tuesday.

If Dr. Summers' mission was to describe mounting political pressure in Washington, it is not clear what he could have said that would have surprised his hosts. The Chinese have certainly already heard of Sen. Schumer (D-NY) and they have undoubtedly read the Ryan-Murphy bill in the House.

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In 2009, the Group of 20 nations committed themselves to rebalancing the world economy. Summiteers in London and Pittsburgh resolved that the large trade surpluses and deficits that had characterized the global economy in the lead-up to the financial crisis should no longer be tolerated.

The G-20 leaders were so effective in their proclamations that much of the requisite rebalancing took place in anticipation, before the leaders could even implement any collaborative policies. China's current account surplus of $426 billion in 2008 fell 33 percent to a surplus of $284 billion in 2009. The Middle East, which as a region ran a surplus of $348 billion in 2008, saw it drop 90 percent to just $35 billion in 2009. The United States current account deficit of $706 billion in 2008 shrank by over 40 percent to $418 billion in 2009.

Such anticipatory compliance on the part of the world economy would have been most welcome, had it only continued. Yet recent economic data shows it has not. The New York Times summarized the latest numbers:

The United States trade deficit ballooned to $49.9 billion in June, the biggest since October 2008. In July, one month later, China recorded a $28.7 billion trade surplus, the biggest since January 2009. In the first five months of the year, Germany's trade surplus... rose 30 percent compared with 2009, to about $75 billion.

So what does this mean? Before the world's leaders could even assemble, the imbalances shrank, but once they issued their proclamations, the imbalances revived. The moral is that trade balances are driven by deep-seated forces within an economy and are difficult to manipulate. The shock of the housing bust and financial crisis dampened consumption and, thus, imports. Some countries were hit harder than others. U.S. monthly imports peaked at $232 billion in July of 2008. They bottomed out at $151 billion in May of 2009. That 35 percent plunge is a pretty good depiction of economic panic. Over the same period, exports fell by "only" about 24 percent, and they were smaller than imports to begin with (hence the deficit).

Of course, relative consumer confidence around the globe was not the only factor driving these numbers. There were also wild exchange rate swings as investors tried to puzzle out which of the world's major markets posed the least risk.

The point is that none of this was due to the fine-tuning of finance ministers or chancellors of the exchequer. They were all trying everything they could to restore confidence among consumers and investors and to revive economic growth. The standard tools that would be used to manipulate external imbalances were instead directed toward crisis response. This is unlikely to change in the near future. China is much more worried about steering between their Scylla and Charybdis of inflation and unemployment than it is about its trade surplus with the United States. Fed Chairman Ben Bernanke is far more preoccupied with concerns about a double-dip recession and deflation than he is about the value of the dollar. Their moves may end up shrinking global imbalances -- significant new quantitative easing by the Fed might depress the dollar --  but this would not be the principal intended effect.

From an economic standpoint, the inability to tackle the imbalances is less worrying than some commentators made it seem. There was a connection between a global savings glut (one aspect of the imbalances) and the U.S. financial crisis, but the latter did not follow inevitably from the former. It took a whole raft of unwise U.S. domestic policies to mishandle the offer of cheap global funds (e.g. offering mortgages with no money down to purchasers of dubious credit was problematic). Similarly, there is no inevitable link between trade deficits and unemployment. Countries with flexible exchange rates and sound policies can adjust to all kinds of external shocks, though the adjustment may be painful.

From a political standpoint, however, the situation may be more dire. Michael Pettis, an astute observer of the Chinese scene, this week concluded that "The world seems to be marching inexorably towards trade war." He argued that the United States will be forced to choose between protection and soaring trade deficits, with the former threatening an ensuing round of global protectionism.

The issue will re-emerge in Washington when Congress returns next month. The Obama administration won a respite from Congressional pressure when China agreed to allow its currency to move in June. Since then, the Chinese yuan has appreciated from a rate of 6.83 to the dollar all the way up to 6.80 to the dollar (less than half a percent). Congressional hearings are already scheduled.

None of this is to argue that it was wrong for the world's major nations to try to address imbalances at their 2009 gatherings, just that the problem is more intractable than they acknowledged. To navigate the economic and political imperatives successfully will require substantially more deft diplomacy.  

From an otherwise tepid weekend of international economic summitry, the most striking development was the Obama administration's declaration that it intends to move forward with the Korea free trade agreement (FTA). President Obama announced that he wanted renegotiations completed by his visit to Seoul in November and that he would submit the agreement to Congress shortly thereafter.

Amidst faltering progress on global trade talks and discord over stimulus and deficit reduction at the global talks in Canada, it would be easy to miss the import of the Korea announcement. The Korea-United States (KORUS) FTA was completed in 2007 but President Bush could not persuade the Democratic-controlled Congress to put it to a vote. The Koreans passed the agreement long since, but it has lingered in U.S. legislative limbo under the Obama administration. The Obama team had characterized KORUS as unsatisfactory, citing shortcomings in barriers to auto trade and beef, but had been unwilling to present the Koreans with a list of necessary fixes. To do so would have been to imply that remedies would lead to passage.

This new move represents a sharp break with Obama administration trade policy to date, and arguably with the administration's approach to legislation more generally. Administration trade policy so far has been characterized by deliberate ambiguity and an avoidance of deadlines. The Obama administration joined the G-20 nations in calling for a conclusion to the WTO trade talks last year, but resisted deadlines like a ministerial review last March. It stated general support for mending and passing the pending FTAs with Colombia, Panama, and Korea, but never put forward a timeline. It called for "engagement" with the Trans-Pacific Partnership, but left details vague and did not set a target end-date for those negotiations.

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Did the Obama administration just score a big foreign policy victory on Chinese currency practices? Over the weekend, China announced that it would let its currency begin to move for the first time in years. As trading for the week opened, the Chinese renminbi (RMB) broke free from its long-held 6.83 rate to the dollar, and rose above 6.80.

This certainly seems like the successful culmination of a strategy the administration pursued at some political risk. In the spring, pressure was mounting on the Treasury to name China a "currency manipulator." The administration resisted the pressure and ignored the Congressionally-mandated April 15 deadline for a determination. Top administration officials persuaded Congress to await the outcome of multilateral efforts to persuade the Chinese to move. Key Congressional figures, like House Ways and Means Chairman Sander Levin (D-MI) set out a new deadline: get results by the G-20 meetings at the end of June, or Congress would act.

Now, the Chinese seem to have responded in the nick of time. Not only did China seem to relent, but it did so on the eve of the G-20 summit in Toronto. The Obama administration had previously trumpeted the elevation of the G-20 as the world's premier multilateral forum as a principal foreign policy success of its first year.

So what's not to celebrate?

China has long said it would change its policy; it had just not said when. In its weekend announcement, Chinese authorities were exceedingly vague about the specifics of the new policy. The only real clarity is that the change will not be a dramatic one-off appreciation of the sort that some U.S. critics of China have been calling for.

The most likely outcome is that the RMB will bounce around as it gradually appreciates, perhaps at a rate of 6 percent per year. This is the most likely outcome only because it is the policy China pursued in the only other instance in which significant appreciation was allowed, from 2005 to 2008. Nouriel Roubini has even noted that the RMB could depreciate, should the euro continue its sharp decline.

The change could be sufficiently minor that the real puzzle is why China did not do this months ago. The move relieves a great deal of international pressure on the Chinese and they incur minimal costs in terms of new competition for their exporters. Now the Chinese are free to spend their summit time criticizing Western budget deficits.

The U.S. domestic politics of China's currency move get complicated. The only position that really united the bulk of Western critics was that Chinese stasis on currency was unacceptable. Some prominent critics pointed to Chinese revaluation as a cure for U.S. job market ills.  Fred Bergsten, Director of the Peterson Institute for International Economics, wrote that Chinese revaluation would be "by far the most cost-effective possible step to reduce the unemployment rate and help speed economic recovery" in the United States. A Washington Post story Sunday cited Bergsten to note:

"A jump of 20 percent (in the RMB) could cut as much as $150 billion off the U.S. trade deficit with China and create as many as 1 million U.S. jobs by making American exports more competitive..."

This weekend's move will not come close to meeting those expectations. The analysis promising job gains is problematic at several levels. For example, in our sole previous experience with Chinese appreciation, the 20 percent rise from 2005 to 2008, the U.S. bilateral trade deficit with China actually expanded.

A more fundamental issue is that the link between trade deficits and jobs is tenuous. The United States has experienced full employment at times of large trade deficits, and we've experienced painful rates of unemployment at times when deficits were declining. Normally, we think trade deficits have little to do with the overall rate of unemployment. The relatively sophisticated argument being put forward by Paul Krugman is that we are suffering from a ‘liquidity trap,' placing us in an exceptional time in which the standard rules do not apply. That view is controversial, but let's accept it for the moment. There is little indication that the liquidity trap, if we are in one, will go on indefinitely. [A key feature of liquidity traps is that interest rates are near zero, and right now longer term interest rates are not]. Thus, if Chinese currency appreciation were to cure U.S. unemployment, it would have to be big and quick. The Chinese announcement just made clear it would be neither.

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Limiting myself to trade and economic matters,  I had two principal reactions to the new National Security Strategy:

1. Its treatment of international trade is highly compartmentalized and ambivalent;
2. While emphasizing the fundamental importance of a robust economy to national security, it misreads the sources of American economic strength.

Neither of these is terribly surprising. The document is full of aspirations and very light on firm stands or tough choices. With the exception of some references to contemporary events, much of the document could have been cribbed from November 2008 campaign themes. The administration gets points for consistency, but after 18 months it would have been nice to see more progress toward solutions.

On trade, the Obama administration has tended to either say the right thing -- or something that could be positively interpreted by a charitable audience -- and do very little. A standard version of the chorus appears in the NSS:

We will pursue a trade agenda that includes an ambitious and balanced Doha multilateral trade agreement, bilateral and multilateral trade agreements that reflect our values and interests, and engagement with the transpacific partnership countries to shape a regional agreement with high standards."

The problem is that global audiences have become less willing to accept empty rhetoric over time. Over a year into the Obama administration, governments abroad want to see active engagement and definite U.S. strategies to achieve a Doha agreement under the World Trade Organization. Instead, the administration keeps returning to its chorus of vague good will, without accompanying action (as one specific example, the administration has not event requested trade negotiating authority from the Congress).

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Europe's attempt at shock and awe exploded Sunday night, blasting the markets into a Monday of euphoria. Now the dust and debris are settling and we can inspect what just happened. In particular, we can ask whether Europe's big move will solve the problem and what this means for the European Union going forward economically and politically.

To figure out whether it will solve Europe's problem, we first have to decide what the problem is. That, in fact, is at the crux of the matter. There are two very different ways of thinking about the crisis along Europe's periphery (Portugal, Ireland, Italy, Greece, and Spain -- PIIGS):

1. It's a solvency crisis. These countries have let their debts get out of hand. In some cases, it was government borrowing, in some cases private sector borrowing, but in all cases it looks unsustainable. The problem first became apparent in Greece, but investors soon recognized the same symptoms in the other countries. The spread of rising spreads (higher borrowing costs) was not so much contagion as it was a dawning recognition that a number of countries had been afflicted by the same syndrome. Or:
2. It's a liquidity crisis. These countries have some debt problems, but they are really victims of ravenous and amoral speculators. Those speculators create crises, rather than recognize them. When they stampede out of bond markets and drive up interest rates, otherwise viable budget situations become untenable.

Europe's solution of a trillion dollars of backup funds is aimed squarely at the liquidity crisis interpretation. By providing funds to the beleaguered countries at reasonable rates, those countries will have time to get their fiscal affairs in order and work their way out of this mess.

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