China On Notice

Forbes ^ | 17MAY05 | Paul Maidment

[familyop]

NEW YORK - The Bush administration has put China on notice that it expects a revaluation of the yuan within six months.

In its biannual report to Congress on exchange rates and trade, the U.S. Treasury said China will be at risk of being accused of unfairly manipulating its exchange rate if it doesn't act swiftly to abandon its fixed exchange rate against the dollar.

For the past ten years, the yuan has been pegged to trade in a narrow band around $8.28. Beijing has repeatedly said it will widen the band, making the yuan more flexible in time, but the head of China's central bank denied again last week that a revaluation was imminent.

The Treasury report can be seen as the administration's response to a bill put forward by Senator Charles Schumer, D-N.Y., that would impose heavy sanctions if China does not revalue in the next six months.

The report and a statement from U.S. Treasury Secretary John Snow played a major role in turning around U.S. stocks Tuesday afternoon after they had been hammered on inflation fears when strong Producer Price Index and monthly housing starts numbers were posted before trading began. The Dow Jones Industrial Average posted a second straight day of gains--rising 79.59 points to 10,331.88.

The Treasury report makes clear that China would meet the requirements of being named a currency manipulator if there is no substantial change in its currency regime within six months.

"It is widely accepted that China is now ready and should move without delay in a manner and magnitude that is sufficiently reflective of underlying market conditions," the Treasury report says.

"It is critical that we address the issues of imbalances aggressively," said Snow's statement. "China's rigid currency regime has become highly distortionary. It poses risks to the health of the Chinese economy, such as sowing the seeds for excess liquidity creation, asset price inflation, large speculative capital flows and overinvestment," he added.

The Treasury is now saying that China should take an immediate transitionary step towards a full float of its currency, but that Beijing doesn't need to move immediately to a full floating rate regime. This could be as straightforward as a significant widening of the yuan's trading band.

U.S. Congressmen and U.S. export manufactures would welcome an immediate signal of intent to allay their concerns about the U.S. trade deficit with China which they argue is being increased by what they say is China's artificially cheap currency.

China's bilateral trade surplus with the U.S. expanded in the second half of 2004 to $93.5 billion, compared to $70.2 billion in the same period the previous year.

China's global current account surplus had increased to $40 billion in the second half of last year, or 4.2% of gross domestic product--roughly twice as large as the surplus in the second half of 2003.

Though China has already been working on financial market deregulation for two years, preparing to loosen the yuan's peg to the dollar, and has gradually sought to give its financial institutions more experience operating in foreign exchange markets. China's capital markets would require substantial further liberalization to sustain the impact of a fully free float.

Further interest-rate liberalization is also crucial. If the central bank loses its exchange-rate control over monetary policy, it needs to be able to affect either of the only two alternative policy tools: a target interest rate or a target inflation rate, and targeting the latter is impractical.

Earlier this month, Vice Finance Minister Li Yong told the annual meeting of the Asian Development Bank meeting that China had to first get its market mechanisms in order and repair its corruption-ridden and bad-debt burdened banking system.

Many in Congress have been critical of the administration softly jawboning the Chinese authorities over the issue of the yuan. But the administration has been reluctant to take a more forceful approach, in public at least, for fear that the Chinese authorities won't want to be seen within China as bowing to foreign pressure, and particularly not American and Japanese pressure. (Tokyo has made similar calls for revaluation.)

Note that the Treasury report is diplomatically couched in the language of global economic imbalances rather than the bilateral U.S.-China relationship,

"The fixed exchange rate China now maintains is a substantial distortion to world markets, blocking the price mechanism and impeding adjustment of international balances. It is also a source of large and increasing risk to the Chinese economy," the report concludes.

[A. Pole]

Didn't Arthur Andersen swear on a stack of financial disclosure documents that China's economy is growing faster than anyone else's?

Whatever, Chinese banking system is not very good.

[BeHoldAPaleHorse]

"For 2004, China had a $120+ Billion trade surplus...but China spent $195 Billion on the global currency markets to keep their Yuan under-valued. That sort of game can't last forever."

Lose money on each transaction, then make it up in volume? :)

[oceanview]

why do you think china uses a currency peg? I guess they must have talked with Jack Kemp, the currency peg makes them an enterprise zone. what is the effect of the enterprise zone concept in the US, creating artificially low cost "havens" (in the case of our domestic economy, through the tax code) for businesses. what is their purpose? well, to attract capital investment of course, so that businesses will relocate into that zone. that's why China does it.

china maintains the peg because they want to suck up all US industrial investment into their country. they realize that semiconductor plants, biotech, auto production, are alot more important long term then more shopping malls and Applebees.

[oceanview]

glad you are here.

[Brilliant]

Yeah, sure. That's their logic. But we've been doing this capitalism thing for a lot longer than they have, and we know a whole lot more about it than they do. They are basically subsidizing the American consumer with their currency peg. That's fine with me. Let them subsidize us more.

Of course, I will will be the first to admit that if things get out of hand, and they can't keep it up any longer, then there will be consequences. The dollar will go down, and we won't be able to buy those TVs at cut rates anymore. When that happens, some people might say "we told you so." But that just shows what I've been saying all along: So long as the currency peg is in place, it's like they are giving us free money. How would we benefit if they end the peg sooner?

[NewLand]

they realize that semiconductor plants, biotech, auto production, are alot more important long term then more shopping malls and Applebees.

True, but you present no case that supports your position except cheap currency. That cannot last forever. Being the world leader in innovation and industry takes a lot more than just low cost labor and undervalued currency.

It takes a culture of industry and capitalism and freedom to sustain all that. We have that, China doesn't, and China won't have that, not for a long long time, if at all.

Instead of being so paranoic about China (remake of the Japan Inc paranoia of the 80's) we need to focus on our own problems like the education and competitiveness of our schools and our youth.

[Brilliant]

"I first have to have a job..."

I agree. So do something other than make TVs, radios, textiles, or furniture, and you've got a job. There are plenty of jobs in America. We've got no job problem, and if we did, it would not be the fault of the Chinese. It would be the fault of the Fed.

[ikka]

Politicians positioning themselves for 2006 elections. It will take at least 2 quarters for the positive effects to be seen in the economy, so any revaluation must be done by December 2005 or so, so that by November 2006 the economy will get a bump.

[oceanview]

technological development takes place in countries where engineers are employed and investments are made. The US has no special "god given" culture of technological innovation - it takes investment and people. and when those investments are not made here, and when those engineers are not produced here - we won't have that going on here. Its happening already - parents are pouring their kids into law schools, engineering programs are collapsing. and its not because our schools are bad - its because there is no economic incentive to go into the sciences.

[Southack]

"Maybe if they set the peg at 0 dollars to the yuan.... That's lower, right?? So they'd be giving their stuff to us for free. Why is that bad?"

It's "Bad" because that sort of product dumping causes an unhealthy addiction as well as the investment of your wealth into the wrong areas...

...For the same reason that dope pushers give away that first free sample, to get you hooked.

Well, that's what robber barrons and monopolists have done throughout history; they've been willing to endure short-term losses in order to gain a long-term lock on a Market.

Whether you are talking about railroads in 1900 or Standard Oil in 1925 or AT&T in 1950 or OPEC in 1975 or China in the 2000's, they were (and China still is) willing to lose money in the short term to gain or maintain their absolute monopolies for the long-term.

China is essentially dumping their goods on us right now, but our anti-dumping laws can't touch them because the laws didn't cover currency manipulation back when they were written. By dumping their subsidized goods onto the Market, no one else can compete with them...driving their competition out of business.

That's not capitalism. That's direct foreign government intervention into global economies to the tune of more than $195 Billion per year in currency manipulation expenses.

Of course, such low-cost goods are addictive. To the consumer, anyway. Everybody *wants* lower cost products just as the dope junkie wants another high. But that doesn't make it right, and it certainly isn't healthy for us or our long term economy.

Though granted, it's a lot of fun in the short term.

[oceanview]

if they end the peg sooner, china becomes a less attractive place for US industries to invest - they will instead invest here in the US instead - creating jobs (not low wage service jobs), a tax base, etc.

[groanup]

Thank-you for making a reasoned post on this thread.

[NewLand]

They are basically subsidizing the American consumer with their currency peg. That's fine with me. Let them subsidize us more.

Agreed, and, that will be status quo until our continued innovation in technology will raise the bar and create newer, higher valued businesses that China will have to play catch up to all over again.

As this happens, we cast off our lower valued manufacturing needs to lower cost producers like China and India. This is why the USA continues to grow and create wealth, while other countries remain in stagnant, government subsidized economies that eventually will collapse or recess.

Just look at Japan...they have gone full cycle on all of that.

[Brilliant]

Let them give TV's, clothing, and radios to us for free. We'll see who it's bad for.

We don't even make those things anyway, with the exception of a very few textile plants which are constantly on the verge of bankruptcy anyway because they can't find workers who are willing to work for the low wages they pay.

[groanup]

Its happening already - parents are pouring their kids into law schools, engineering programs are collapsing. and its not because our schools are bad - its because there is no economic incentive to go into the sciences.

LOL!

[NewLand]

parents are pouring their kids into law schools, engineering programs are collapsing. and its not because our schools are bad - its because there is no economic incentive to go into the sciences.

Source for these statements? Anything to back any of it up?

[oceanview]

so why is Treasury calling for this? I think they finally understand its getting out of hand. I am not sure why they haven't seen it already, apparently it took this whole textile thing (and a strong stand by the Europeans) to cause the flash point. the US textile industry has invested billions in automation, and in fact the cost of apparel has been declining to the US consumer as a result. But now, they understand that without the import restrictions, no amount of investment in the US can compete with a pair of Dockers that can be imported at $4.75.

[A. Pole]

But we've been doing this capitalism thing for a lot longer than they have

Chinese were good at business for a few thousands of years. Socialism was a very recent event and they had socialism once several centuries earlier.

China is a really old nation like Greeks, Jews, Persians and Indians are. And very likely they will outlive us.

[ConservativeMan55]

bttt

[oceanview]

I see it everyday at work - none, and I mean NONE, of my colleagues with college bound children are sending them for engineering. NONE will follow in their parents career paths, because their parents see what is going on. trust me, its happening. if not for the enrollment of foreign nationals, US engineering programs would be closing up in droves.