THE United States Senate's recent bipartisan passage of the proposed Currency Exchange Rate Oversight Reform Act of 2011 is yet another indication that the US presidential election season next year is definitely, if prematurely, upon us.

Most people believe that so many senators (62 out of 100) were willing to vote for the Act (which has been around in some form for years) because it has little chance of becoming law.

That is fortunate for the US, China and the rest of the world, including Singapore, since none would benefit economically from it, and most would be hurt by it. It would punish countries whose currencies are 'misaligned' - or undervalued and thus subsidising their exports - by imposing large tariffs on their imports into the US.

The Act will impose hardship on US consumers, especially price-sensitive low-income consumers who are already hurting from the weak economy. It would raise the cost of buying China-made products (for which there are often no good domestic substitutes) and reduce the amount of income left to purchase other US-produced goods and services.

It will also hurt the many US-based businesses whose supply chains are heavily dependent on intermediate input imports from China, causing them to lose competitiveness and market share at home and abroad, as their costs rise and their profits are squeezed.

Any jobs created by reduced US purchases from China will most likely be created in other developing countries which share China's comparative advantage in relatively labour-intensive activities, not in the US.

China's likely retaliation would hurt US exports and might hurt US companies operating in China and profiting from its booming domestic market. Such retaliation is likely to arise from the Act not being compliant with World Trade Organisation rules, which permit the imposition of punitive 'countervailing duties' against export subsidies, but have never considered an undervalued currency as an export subsidy.

Definition of what constitutes 'currency manipulation' is also problematic, since the world is full of countries that fix or manage their currencies for one reason or another. In the unlikely event that the Act does become law, Singapore could be among those targeted for having a 'misaligned' currency, since it runs the world's largest current account surpluses as a percentage of gross domestic product (GDP) - between 20 per cent and 25 per cent of GDP - for more than two decades.

The protectionist sentiment behind the Act will also discourage Chinese investment in the US. With US consumer spending, business investment and government expenditure all stagnant or declining, exports and inward foreign direct investment remain virtually the only sources of growth for the anaemic (but not yet recessionary) US economy. 

As a means to pressure China to strengthen its currency, the Act is unnecessary and may be counterproductive. China's government decided years ago to let the yuan appreciate, given the costs to its economy of an undervalued currency - which include domestic inflation, loss of consumer welfare and the devaluation of its accumulated foreign assets in yuan terms as the currency strengthens.

The yuan has already appreciated by 30 per cent in nominal terms since 2005, and by much more in real terms, taking into account high inflation in China since the global financial crisis. Any residual undervaluation is likely to be relatively small, given that China's current account surplus (excess of exports over imports) has already shrunk from 10 per cent in 2007 to under 3 per cent last year.

The Chinese government has also shown its displeasure about the Act by slowing and perhaps even stopping the yuan's gradual appreciation (though this is as likely to be motivated by the slowing growth of China's export markets in Europe and the US). With its own leadership transition coming up also next year, it cannot afford to be seen by its own population to be ceding to foreign pressure.

More rapid yuan appreciation also means the Chinese will buy less or sell more US dollar assets - including US Treasuries, which fund the US government budget deficit. This could raise US interest rates, making it more costly to fund consumer purchases, business investment and the budget deficit, further slowing GDP growth and causing job loss.

In any event, current account imbalances are determined by domestic macroeconomic imbalances rather than by exchange rates, with the US deficit resulting from low domestic savings and a large budget deficit, and China's surplus from high domestic savings. Thus, a quarter-century of yen appreciation (from 250 yen to the US dollar to the current 75 yen) has not eliminated Japan's current account surplus with the US.

Why, then, did the Senate pass an Act that is so clearly a 'job killer', and so risky for the stability and recovery of an already shaky world economy?

The answer, as so often, lies in domestic politics. Nearly every US presidential candidate since Mr Bill Clinton has used China as a bogey in his election campaign - and that includes not just Mr George W. Bush (Harvard MBA) and President Barack Obama (Harvard JD), but also current Republican candidates Mitt Romney (Harvard MBA) and Jon Huntsman (Wharton MBA), both of whom are former business leaders who should, and do, know better. The Mandarin-speaking Mr Huntsman is even a specialist on, and former US ambassador to, China (and before that, to Singapore).

Electoral candidates may pander to the voting public, who cannot be expected to understand the arcane analytical and empirical complexities of exchange rates, and who often seek foreign scapegoats to blame for their domestic woes (in which case Europe should be more of a target than China this year).

A president, however, cannot do this, as he must act in the best interests of the country at large (and also relies on the business community for much of his campaign's financial support). This makes him vulnerable to accusations on the campaign trail of 'selling out to the Chinese'.

Fortunately, despite the current predilection of Republicans and Democrats for blaming each other for everything under the sun, so far Mr Obama has been helped by Republican House Speaker John Boehner in preventing the Act from coming up for a vote there (where it would probably pass by a wide margin, forcing a presidential veto). Now that is the kind of bipartisanship that America - and the world - could use

The writer is professor of strategy at the Ross School of Business, University of Michigan, in the United States.

Source - The Straits Times (http://www.straitstimes.com/Review/Others/STIStory_725905.html)