This is the most intelligent thing Geithner has done.

If we label China a currency manipulator, China “must” either respond by increasing their currency value, thus increasing the costs of their exports, or by accepting trade sanctions that increase the costs of their exports. Either way, cheap stuff from China will not be so cheap. In truth, the range of Chinese responses could be greater, but this seems to be the prevailing wisdom about the label. Never be surprised when someone says a small number of outcomes “must” be realized when it comes to international politics and the outcome differs from the enumerated list.

Now, what does the label do for the US? Well, it means that our standard of living falls. We will pay more for the goods we currently buy from China. Worse, the goods that Chinese goods displace are no longer produced in the US. I suppose alternatives are made in Japan, Mexico, and Europe, but by and large, we will bear the increased costs of imported goods without garnering much benefit to our own manufacturing base. Still, the balance of trade will become more favorable. This will be a product of us buying less stuff, not a product of us exporting more. There are some potential long term gains to be made by US manufacturers, but we’d have to deal with the immediate consequences first.

There could also be knock-on effects from this. China’s exporters operate off of razor thin margins (note that this link actually puts quite a bit of blame on the weak yuan as a cause of the Chinese manufacturers’ inefficiency—subsidies always create inefficiencies). If the yuan appreciates in value, a few hundred thousand will be added to the ranks of the unemployed. That may be enough to pop the Chinese bubble.

Australia has the most to gain in the short term from a stronger yuan. Australia is a significant trading partner with China and a source of raw materials. Of course, this relationship only holds promise until China’s bubble pops. The short term can last as long as China finds other ways to subsidize their manufacturers. That will probably go a few rounds, but they would be short rounds (it’s far easier for nations to complain about subsidies to exporters and take retaliatory measures than it is to complain about currency manipulation). Eventually, the decrease in activity would hurt Australia. Hopefully they prosper enough in the short term to handle the aftermath.

I’m not going to belabor the China-dumps-US-Treasuries scenario because while it has catastrophic consequences, it still remains a fairly low-probability event.

So what does a delay in the report do? It allows China some time to provide a token appreciation. A 1% appreciation in the yuan might satisfy enough politicians that the currency manipulator designation can be delayed another year. That would provide some time for Chinese domestic consumption to increase and allow the whole process to restart next year, hopefully a little closer to where we believe equilibrium to be. Of course, if the Chinese bubble bursts in the interim, expect further devaluation attempts. These attempts will ultimately fail, but they will provide some interesting reading.

Imbalances are like bubbles. They can go on far longer than people expect. The longer they go on, the more painful the correction. The trade imbalance with China has already reached a point where a correction is guaranteed to be painful. The long term benefits probably do outweigh the short term consequences (provided China doesn’t use the nuclear option, economic or literal). However, from a political standpoint, I would favor waiting for China to implode on their own accord. Even better would be if China stopped their bad behavior on their own, though I don’t think this delay makes that scenario much more likely.

I would again like to point out that I don’t favor the artificial suppression of a nation’s currency. The low yuan has probably produced a greater threat to Chinese stability than to American stability, though. My concern is that the chronology of events will make things worse for us. If we first force China to reduce their imports, and then China’s bubble bursts, the internal pressures for China to retaliate against the US for causing their problems could lead to problems for us. If the Chinese bubble collapses under its own weight, the threat of retribution is probably reduced. Unfortunately, there’s no predicting when the Chinese bubble will burst. These imbalances might grow larger with even more devastating consequences (for us before and for China after). I will even add that China is better able to sustain larger bubbles than the US because they operate a command economy.

What is important to me is that we don’t ignore the existence of risks of the path we choose. Economists like Krugman are right to point out that a weak yuan has hurt American manufacturers. However, it (artificially) accelerated an increase in the quality of life for Americans. Also, it doesn’t automatically follow that increasing the value of the yuan will necessarily help American manufacturers. The damage was fatal to many manufacturers. The benefit will likely be to other foreign manufacturers. American exports will not likely substantially increase to China. Our automakers’ profits will probably increase, but that won’t provide any manufacturing jobs here in America. Those will be Chinese Ford and GM jobs. That’s another consequence of this delay, that we go forward with our policy with some understanding of where it might lead.