Washington-Beijing currency friction: the latest flash points in the U.S. Congress.

• Author: Mastel, Greg

While China's trade surplus with the United States has ballooned in the last two decades, the United States and China have had a growing list of bilateral trade disputes ranging from restrictions on exports of rare earth metals to Chinese subsidies of new energy technologies. Now one issue, China's controls on the exchange rate of its currency--known as the renminbi, or yuan--with the dollar has come to eclipse all others. At least on this side of the Pacific, the consensus that China's currency policy is unfair and should change is broad enough to encompass both "big business"--the National Association of Manufacturers--and leading labor unions. Even both President Obama and his 2008 opponent Senator John McCain have criticized Beijing's currency policy and it seems most members of Congress agree.

Those opinions are well-founded as there is strong evidence China has pursued a policy of keeping the renminbi artificially weak versus the dollar. China's primary motive boils down to modern mercantilism: a cheap renminbi makes China's exports relatively cheap and imports into China relatively expensive, which stimulates manufacturing employment in China. China is certainly not the first or only country to pursue such a weak currency policy. Many other countries--most notably Japan--have been accused of doing the same thing over the years.

But China appears to be acting on a scale without precedent. In order to defend the renminbi at below-market rates, China has steadily acquired dollars and dollar-denominated assets in order to make dollars scarcer and thus more expensive relative to the renminbi.

Beijing added nearly $200 billion to its foreign exchange reserves--mostly dollars--in just the last quarter of 2010. As a result, China has acquired a staggering total of nearly $3 trillion in dollars and dollar-denominated assets, far more than any other country. In the last five years, China's trade surplus with the United States has remained firmly stuck at over $200 billion per year. Unquestionably, a number of factors contribute to that imbalance, but it would be difficult to argue that China's currency policy is not one important driver of the continuing imbalance.

As the U.S. Department of the Treasury--hardly a nest of currency hawks--summarized in July of 2010: "China's continued rapid pace of foreign reserve accumulation; the limited appreciation of China's real effective exchange rate relative to rapid productivity growth in the traded...