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.

[groanup]

so why is Treasury calling for this? I think they finally understand its getting out of hand.

So why didn't they listen to one of your earlier, breathless, posts and act then?

[oceanview]

how about semiconductors, software, biotech, autos, machine tools, aircraft subassemblies. its not just xmas tree lights, radios and t-shirts anymore. there are some posters here who have first hand experience in china, they can tell you what they are investing in over there, what industries they are looking to capture - it ain't xmas tree lights and brooms anymore.

[Brilliant]

They are in a rut. Mao doesn't hold a candle to Greenspan.

[NewLand]

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.

I totally agree. That is why the USA will continue to be the leading economic force and technological power for the forseeable future. Just because we lose some of the lower value manufacturing industries does not mean we are losing our position of leadership *or* mortgaging our future, as some of the other doom & gloom posters like to wring their hands about.

[Southack]

"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?"

Business investments will come back to the U.S. from China in proportion to how high the Chinese Yuan climbs against the Dollar. The sooner, the better, the higher, the better...for jobs, infrastructure, and long term investments here.

Delay the Yuan re-evaluation and you delay (or even lose) those business investments that are going to China in the meantime.

In the short-term, however, you are correct that the overall sum and status quo benefits the U.S.

China is spending $195+ Billion to make a $120+ Billion trade surplus...so America is financially better off by more than $75 Billion per year in accounts recievable.

However, you've got to then subtract the lost U.S. business investments that instead went to China (from the U.S. and other countries) to get a more clear overall picture. I'd have to look it up, but I'd guess offhand that China had $30+ Billion last year in foreign direct business investments into China.

Frankly, I'd rather have a more equitable and fair...overt economy rather than one that's being directly manipulated via currency manipulation, and the sooner the better. Oh yeah, there is also the Magic Dollar effect in play here. A Dollar paid to a U.S. employee will typically be spent in the U.S., where it will help pay the salary of another U.S. worker, who in turn spends her Dollar in the U.S. in a Magic Dollar virtuous cycle...but that wonderful leverage that we see via the Speed-of-Money disappears when the U.S. worker spends her Dollar on a foreign product. Poof! The leverage is gone. She got a cheap product and saved a few cents, but that Dollar is no longer in the domestic Magic Dollar cycle.

I'm just not excited about seeing a small net financial gain (whoo hoo currency traders! Lets all go work in the pits!) for the U.S. at the expense of losing our entire manufacturing base...especially when one considers that at some point in the future we'd be vulnerable to an OPEC style product embargo strategy from places like China.

[oceanview]

they apparently see it now. the real question to be asked is why you do not.

[groanup]

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.

Oh, I believe you. The people you work with aren't sending their kids to engineering school. I understand. I'm not sending my daughter to medical school either. She's made her own decision to go there. Unfortunately it isn't international trade or NAFTA or India or China that is causing otherwise intelligent kids to shun difficult majors. It is the absolute decline of public (government) schools beginning with the early grades. We have dumbed down our children to the point where the only thing they can understand is what a liberal political science teacher says.

[NewLand]

NONE, of my colleagues with college bound children are sending them for engineering.

Now there's a reliable source for making global statements! Please...

[oceanview]

with what industries are we going to be this "leading economic force"? starbucks, Applebees, walmart and target? and government, and health care? and lawyers? and financial services? and real estate?

[groanup]

they apparently see it now. the real question to be asked is why you do not

Oh, I do, I do. I just wish they had been as prescient as you and nipped this problem in the bud.

[oceanview]

search google, you can find dozens like this:

http://www.mercurynews.com/mld/mercurynews/news/8263034.htm

and believe it, because its true.

[Brilliant]

The only two reasons I can think of why the Treasury would support putting pressure on China are these: 1) Bush told them to do so, and 2) they are worried about the dislocation that would result if China suddenly stopped pegging the dollar.

My view is that it won't happen. The Chinese might slowly move the peg closer to the market rate, but it's not in their best interest to suddenly end the peg. In any event, if it were to happen, it would hurt them a whole lot more than us. They are pegging the dollar by using dollars to purchase US bonds. If they suddenly stopped supporting the dollar, then the value of those bonds would decline precipitously, and we'd pay them back with dollars worth less. More their problem than ours.

The decline of the dollar would of course cause some inflation, but only because the cost of imports would increase, which is what you want anyway. So why worry? The worst thing that can happen is that you end up having your way in the end.

[NewLand]

It is the absolute decline of public (government) schools beginning with the early grades. We have dumbed down our children to the point where the only thing they can understand is what a liberal political science teacher says.

Bingo! I stated the same earlier in the thread. This is a very fixable problem for the USA.

We send our kids to Christian schools and do not experience the PC trash of gubbermint schools.

[groanup]

with what industries are we going to be this "leading economic force"? starbucks, Applebees, walmart and target? and government, and health care? and lawyers? and financial services? and real estate?

psst!...check the latest trade balance figures. Exports were a record. Somebody forgot to tell the rest of the world to stop buying stuff from us.

[groanup]

We send our kids to Christian schools and do not experience the PC trash of gubbermint schools.

Tip of the hat to you. We sent ours to private schools in Elem and then to a carefully chosen public high school where my daughter will graduate next year as valedictorian and plenty of academic scholarship offers. You CAN get your kids a good education if you try hard enough.

[Southack]

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

That sort of argument is akin to telling a dope junkie that his "high" is bad...no one in that position would believe such a thing.

Of *course* consumers want nearly-free consumer goods. That's not in question. It's not even debatable.

It's the *other* side of the equation that isn't being mentioned by such an argument, however...

...the business investment losses.

Because while the product dumping is going on due to this currency manipulation, the clear way to "compete" is to invest in China. If you can't beat them, join them and all of that nonsense.

Which means that new investment Dollars are pouring into China...Dollars that would have gone into U.S. investments if China wasn't subsidizing their exports by under-valuing their Yuan.

...And it's the loss of those business investments to China that is bad, not the (nearly) free products that we get from China.

Lose enough of those investments and suddenly we've just "sold" an entire market monopoly to China in exchange for saving a few pennies on a knife at Wal-Mart.

And losing an entire market means that China will be able to set prices in the future...the goal of every monopolist.

Worse, it means that more and more U.S. Dollars are leaving our domestic Magic Dollar cycle...diluting our own financial leverage.

When our Magic Dollar leverage is factored in, and when our lost business investments are factored in, suddenly those "free" TV's aren't so free anymore.

Which is the same thing that the dope junkie learns when the last high runs out.

[groanup]

search google, you can find dozens like this:

Please cut and paste something. I don't want to sign up for Mercury News. Unless of course you are telling us there are dozens of "Mercury News" sites on Google.

[A. Pole]

with what industries are we going to be this "leading economic force"?

Nanotech brain surgeries performed on the freetraders by the retrained buggy whip makers.

[oceanview]

disable your cookies and try the link again.

[oceanview]

fine, get them a good education. then send them to school for engineering where they are competing with Indians and Chinese making 20% the US wage, and watch what happens to their careers.