merican workers can compete dollar for dollar62 against Chinese workers. They just can’t compete dollars against manipulated yuans.

—Eric Lotke, Campaign for America’s Future

If money is the root of all evil, then China’s manipulation of its currency, the yuan, is the tap root of everything wrong with the U.S.–China trade relationship. For more than a decade, chronic U.S. trade deficits with China have dramatically slowed America’s economic growth rate and spiked our unemployment rate. Yet it would be impossible for China to keep sucking the lifeblood out of the American economy without its fangs of currency manipulation.

China manipulates its currency by artificially “pegging” the Chinese yuan to the U.S. dollar at a grossly undervalued fixed exchange rate. To understand why this debilitates the American economy, it is critical to understand that any nation’s economy is driven by only four factors: consumption, business investment, government spending, and “net exports.”

This last growth driver—net exports—is the most important for our discussion of Chinese currency manipulation because it measures the difference between how much we export to the world minus how much we import. And here is a critical observation that underscores the essential role that net exports play in our economy:

When America runs a chronic trade deficit with China, this shaves critical points off our economic growth rate. This slower growth rate, in turn, thereby reduces the number of jobs America creates.

Of course, as the American economy suffers from slow growth and high unemployment, China enjoys just the opposite effect. The Dragon booms while America goes bust.

Another Day Older, Deeper in Debt, and Slower in Growth

So just how big is our trade deficit with China? Just how many jobs has our “Chinese import dependence” cost us? And why is currency manipulation a principal reason the United States is unable to significantly reduce its trade deficit? Only by knowing the answers to these questions can we escape from China’s currency manipulation trap. Let’s start then with the size of the U.S. trade deficit.

In terms of absolute size, America imports almost $1 billion a day more than it exports from China every business day of the year. That’s not a typo; it’s billion not million.

In terms of relative size, the U.S.–China trade deficit is equally astonishing. China accounts for almost half of our annual trade deficit in goods and fully 75% when petroleum imports are removed from the calculation. Here is one logical policy inference from these statistics:

If America wants to reduce its overall trade deficit to increase its growth rate and create more jobs, the best place to start is with currency reform with China!

As for the actual impact our Chinese import dependence has had on America’s growth and unemployment rates, this, too, is mind-boggling. Over the past decade, our trade deficit with China has typically shaved off close to half a point of GDP growth a year. While that might not seem like a large sum, it translates into a cumulative impact of millions of jobs that the American economy failed to create. If we had those jobs right now plus the millions more manufacturing jobs that China’s unfair trade practices have destroyed outright, we wouldn’t be seeing unemployment lines wrapping around government buildings, fields of padlocked houses under foreclosure, and America’s empty factories pushing up weeds. Instead, we’d be on the sunny side of Easy Street.

As a side note, these stunning statistics always remind us of the story about Willie Sutton, the famous bank robber. When they asked Sutton why he robbed banks, he famously replied, “Because that’s where the money is.” Just as banks are where the money is, China’s currency manipulation is where our best hope of reducing our trade deficit—and reclaiming robust economic growth—lies.

Hard Times for America from China’s Hard Dollar Peg

So, just how does China manipulate its currency? It does so by effectively “hard pegging” its yuan to the dollar at a grossly undervalued fixed exchange rate: around six yuan to the dollar. This ultra-cheap yuan, in turn, provides a lucrative subsidy for Chinese exporters while levying a hefty tax on U.S. exports to China. The result of this currency manipulation, working in league with the other Chinese unfair trade practices we have discussed, has been the chronic U.S. trade deficits we have just weighed and measured.

Now here’s the key currency manipulation point: America’s trade imbalance with China could never persist in a world of free trade where China allowed its currency to float freely alongside other floating currencies around the world like the euro, Japanese yen, Swiss Franc, Brazilian real, Indian rupee, and U.S. dollar.

In a world of free trade characterized by completely floating exchange rates, the U.S.–China trade imbalance could never persist because as the U.S. trade deficit rose, the dollar would fall relative to the yuan. As the dollar fell, U.S. exports to China would rise, Chinese imports would fall, and trade would come back into balance. However, by pegging the yuan to the dollar, a mercantilist China subverts this free trade adjustment process—even as it undermines a global free trade framework based on the promise of mutual gain.

The Nuking Dragon Declares a New Kind of War

The Chinese government has begun a concerted campaign63 of economic threats against the United States, hinting that it may liquidate its vast holding of U.S. treasuries if Washington imposes trade sanctions.... Described as China’s “nuclear option” in the state media, such action could trigger a dollar crash.... It would also cause a spike in U.S. bond yields, hammering the U.S. housing market and perhaps tipping the economy into recession.

—The London Telegraph

It’s bad enough that Chinese currency manipulation has left the American economy stuck in first gear while destroying millions of jobs. It is worse that this particular “Death by Chinese Currency Manipulation” also threatens the “Death of American Political Sovereignty.” At the heart of this matter is what the war hawks running China’s central bank have threatened us with. These hawks call it the “financial nuclear option,” and it involves using China’s vast foreign reserves to destabilize America’s banks, stock market, and bond market.

To understand just how credible China’s threat of “dropping the big one” on America’s financial system is, it helps to illustrate more precisely how China manipulates its currency. This process begins when you or I walk into a store like Walmart and buy a Chinese product, after which our dollars are shipped overseas. At this point, to maintain the U.S. dollar’s fixed peg to the yuan, China must promptly recycle our “Walmart dollars” back into the United States by buying financial assets such as U.S. government bonds, U.S. real estate, or U.S. companies; otherwise, upward pressures would build on the yuan.

Now here’s perhaps the most interesting little twist on this currency manipulation tale: Before the Chinese government can recycle any of our Walmart dollars, it must gain control of those dollars from the Chinese exporters that accumulated them. This requires a convoluted process known as sterilization.

To sterilize our Walmart dollars, the Chinese government forces its exporters to buy Chinese government bonds denominated in U.S. dollars. In return for surrendering their greenbacks, exporters then receive about 4% interest on the sterilization bonds. The Chinese government then turns around and reinvests the captured sterilized greenbacks back into U.S. government bonds that pay less than 2% interest. China thereby loses 2% or more in interest on every dollar it sterilizes—and the losses run into the billions!

Just why is the Chinese central bank willing to shoulder such huge losses? It is because the Communist Party is far more interested in creating jobs to maintain political stability and its totalitarian grip on the country than it is in actually making money. That’s one of the big differences between true American capitalism and China’s perverted “beggar thy neighbor” brand of state capitalism. And never mind that in this zero-sum currency manipulation process, many of the jobs that China gains are exactly the ones lost by the American economy.

In fact, this process of Chinese currency manipulation has led to an accumulation of over $2 trillion in U.S. foreign reserves now held by the People’s Bank of China, aka, American’s mortgage banker. To put this astonishing sum in perspective, it’s more than the gross national product of India or Canada, and it’s nearly equal to that of the United Kingdom. It is also bigger than the GDP of South Korea, Mexico, and Ireland combined!

What this astonishing sum means is this: China could take its foreign reserves and buy a controlling interest in all the big American companies listed on the Dow Jones Industrial Average, including giants like Microsoft, Exxon, and Walmart—and still have enough cash left over to buy up majority stakes in Apple, Intel, and Ford.

It is precisely China’s massive accumulation of dollar-denominated foreign reserves that now allows the Chinese Communist Party to credibly threaten to nuke our financial system. As He Fan of the Chinese Academy of Social Sciences has said in threatening the financial nuclear option, if China were to begin dumping dollars, this would “lead to a mass depreciation of the dollar.” And as the excerpt leading off this chapter has aptly described, such a “dollar crash” would “cause a spike in U.S. bond yields, hammering the U.S. housing market and perhaps tip the economy into recession.”

In fact, there is clear evidence that a kowtowing Uncle Sam has already begun to surrender at least some of America’s political sovereignty to China because of the credibility of China’s financial nuclear option. Indeed, any time now that the White House, the Congress, or the U.S. Trade Representative threatens to crack down on unfair trade practices, China fires a missile across our bow by threatening to dump—and in some cases actually dumping—U.S. dollar reserves. Indeed, the existence of this financial nuclear threat goes a long way toward explaining the perennially timid behavior toward China of various U.S. Secretaries of the Treasury over the last decade—from Bush’s Hank Paulson to Obama’s Timothy Geithner.

And please understand this: Over time, it would be extremely naïve for any American to think that China’s “greenback blackmail” will be limited to merely trade issues. At some point, Chinese officials are likely to use this weapon on any one of a number of geopolitical issues: from White House visits by the Dalai Lama and arms sales to India to the ever-present conflict on the Korean peninsula, and the ever-touchy U.S. backing of Taiwan.

China, Can You Spare Us a Gazillion Dimes?

Chinese currency manipulation has not only led to a loss of American political sovereignty. It has also greatly facilitated America’s self-inflicted “Death by Fiscal Profligacy.” Remember: In the process of currency manipulation, the Chinese government must maintain the peg between the yuan and the dollar principally by buying U.S. government bonds. In this way, our Chinese mortgage banker helps American politicians finance our massive budget deficits.

That China helps us finance programs like America’s serial fiscal stimuli and the Federal Reserve’s easy money printing press is no small irony. After all, it is largely because of America’s blood-sucking trade deficits with China that America’s politicians feel they need to keep priming the economic pump with deficit spending—even as we keep getting deeper and deeper into debt to a totalitarian regime benefiting greatly from our demise.

In fact, this whole sad process in which China has become America’s mortgage banker has been part of a Devil’s bargain President Barack Obama has engaged in ever since he took office and broke his promise to get tough on Chinese mercantilism. Here, we need to clearly remember that on the 2008 campaign trail, in key industrial swing states like Illinois, Michigan, Ohio, and Pennsylvania, Candidate Obama repeatedly promised to crack down on unfair Chinese trade practices.

Since taking office, however, President Obama’s Treasury Department, led by the aforementioned Timothy Geithner, has repeatedly refused to brand China a currency manipulator. However, it is precisely such a move that would allow the United States to impose appropriate countervailing duties to eliminate one of China’s most important mercantilist edges. But instead of fulfilling his campaign promise, President Obama has chosen this dangerous devil’s bargain: “You keep buying our bonds, China, and we won’t take any meaningful actions on trade reform.” In this way, the President has wrongly put politics and his administration’s short-term financing needs ahead of America’s prospects for long-term economic recovery. This is dead wrong, because no matter how many trillions of Walmart dollars we borrow back from China to throw at the American economy, these stimulus bucks won’t make any difference—until we achieve constructive currency reform with China.

America Trapped in the Global Economic Elevator

We’re fed up.64 China’s mercantilist policies are hurting the rest of the world, not just America. It helped create the global recession that we’re in. The Chinese want to be treated as a developing country, but they’re a global giant, the leading exporter in the world.

—Senator Lindsey Graham (R-SC)

As a final observation from 30,000 feet, China’s currency manipulation is not just debilitating the American economy. It is threatening to tear asunder the entire global economic fabric and free trade framework. The problem is this: Whenever the U.S. dollar declines against other currencies such as the euro, real, won, and yen—as it now does frequently—the Chinese yuan falls with it. This fall in the yuan against these other currencies in turn provides a mercantilist China with an even sharper edge against competitors around the world—from Europe and Brazil to Japan and South Korea. The results have included the flagging export demand that drove Europe into economic stagnation and the prolonging of Japan’s now decade-long persistent slow growth. Meanwhile, inflation runs rampant in countries like Australia and Brazil due to speculative hot money flows and commodity price appreciation that can be traced directly back to the undervalued yuan.

Throughout all of this—and despite repeated calls from institutions like the International Monetary Fund and World Bank for China to strengthen its currency—China has taken the hardest possible line against reform. This hard line begins right at the top of China’s leadership; as the proverb says, “A fish rots from the head down.”

Consider, for example, this incredulous response from Prime Minister Wen Jiabao to pressure from other members of the G-20 to revalue. Said Wen: “First of all, I do not think the [yuan]65 is undervalued.” Right, Mr. Wen, and the air is clean in Beijing, Tibetans love being part of China, the people speak freely in Shanghai, and your lunar space probe has shown that the moon is made of Swiss cheese.

In fact, with these kinds of absurd responses to international pressure from top Communist Party leaders, it’s hard to tell whether China’s currency manipulation denial is more akin to a Shakespearean tragedy or a Molière farce. After all, of all the countries that stand to benefit from China strengthening its currency, China would benefit the most!

For starters, a stronger yuan would fight rapidly rising inflation in China by lowering the cost of oil, raw materials, and the myriad other inputs China needs to run its factories. As an important inflation-fighting bonus, a stronger yuan would also promptly halt the speculative inflows of “hot money” now inflating both a Chinese stock market and real estate bubble.

Most importantly, a stronger yuan would put significantly more purchasing power in the hands of a woefully underdeveloped Chinese consumer. In this way, Chinese currency reform would make China far less dependent on selling exports to the rest of the world—a vulnerability that represents the true Achilles’ heel of China’s growth model.

Unfortunately, China’s leaders refuse to accept the compelling logic of this message. Instead, these brittle ideologues defend their intransigent position by claiming that strengthening the yuan would destroy China’s economy by sharply reducing its exports. But this is just another way of saying that the only way China can keep growing is by beggaring the rest of the world. One must also consider the obvious possibility that beggaring the rest of the world and, in particular, emasculating America’s economy and manufacturing base is, in fact, one of China’s long-term strategic and military goals.