Bottom Line: China and the sleeping giant

WASHINGTON, Sep 12, 2003 (United Press International via COMTEX) -- Chinese central bankers and trade bureaucrats issued an icy rebuff to Treasury Secretary John Snow early this month, blandly dismissing charts and background documents suggesting its currency, the renminbi yuan, is disrupting not only Sino-U.S. trade flows, but trade, currency, and debt markets worldwide. But the cold water may have awakened a sleeping U.S. giant; specifically long-dormant (but never fully quelched) forces of protectionism on the Democratic left, anti-communist security concerns of the Republican right, and human rights forces in both parties.

Those concerns delayed for years, and nearly defeated outright, the establishment of most-favored-nation status for China early in the Clinton presidency. They have never fully gone away. Although it's doubtful a strongly protectionist bill such as a special tariff would ever receive signature by the president, it's possible that much heat will be raised to force a veto in the coming months. There's even a slim possibility of a 2/3 veto-proof majority -- or a presidential turnaround of the kind that Bush executed on campaign finance, corporate governance and reporting reform, and other issues.

At issue is the seemingly obscure issue of the yuan's exchange rate to the dollar. By engaging in purchases of U.S. dollars and Treasury securities on a massive scale -- China now rivals Japan as the largest purchaser of American debt on a monthly basis -- China has managed to keep the value of the yuan relatively steady against the dollar at about 8.5-1. Normally, given its rapid growth and huge trade surplus on current account, China would have enjoyed a rising currency, as Japan did in the 1970s and 1980s, bringing relief both to other world exporters in competition with artificially cheap Chinese goods, and, not incidentally, to Chinese workers and consumers, who pay artificially high prices for world goods.

Snow made these points patiently and personally to the top leadership at the People's Bank of China and the Finance Ministry. "The meetings," according to one aide, "were something like those scenes between Princess Ardala and the Trade Federation in Star Wars," Episode One.

Snow went in with few arrows in his quiver, hoping that the Chinese would listen to friendly reason. When they didn't, however, he returned to Washington to add a bit of leverage to logic.

In fact, Snow had been back in his office less than two hours before he told aides to go "cooperate" -- albeit passively -- with congressional proposals to slap trade penalties on Beijing if there is not movement on the currency issue. "We're not in favor of it, of course," he said, referring to a Democratic-led proposal to slap a 27 percent tariff on Chinese goods if there is no revaluation of the yuan. "But I don't want them attacked either."

In fact, Treasury officials have actively cooperated with Republicans drawing up an alternative proposal. That bill would impose considerably softer penalties than the Democratic version. It keeps the process going, however, and gives the White House an excuse to sit back for the coming months and pronounce it hasn't decided what to do about China trade proposals, as it doesn't know what form a final bill will take.

Officials from the Council of Economic Advistors, the National Security Council, Karl Rove's and the office of the Vice President have all been trolling around for ideas and proposals to "do something about China" in recent months. Unfortunately, their friends on the Wall Street right believe anything that sounds like protectionism is protectionism. Former Fed Governer Wayne Angell, for example, told the White House he not only wasn't interested in helping raise the heat on China, but that the Administration shouldn't be either.

"It's a non-problem," Angell reportedly told a White House aide who called him prior to the Sino-Snow summit. Whether that's right or wrong as an economic proposition is highly debatable. Politically, Chinese trade is a massive problem for the Administration, Congress, Europe, the rest of Asia, and thus, for the Chinese.

The situation resembles the last major advent of protectionism in the U.S., the advent of Super 301 legislation, aimed largely at Japan and Europe, in 1985. (Concern about the yuan, in my book, is not protectionism. Applying a tariffs as a remedy to that problem is -- but it is the kind of solution free-traders and the Chinese must expect if they decline to accept the more gradual and benign alternative of a rising renminbi yuan.) Then-maverick Congressman Richard Gephardt, the Democrats, and a smattering of rust-belt Republicans teamed up to bring the bill to passage. But the more noxious parts of Super 301 were amended out, or failed to materialize, as Treasury Secretary James Baker took the advice of Jack Kemp, Bill Bradley, and others to bring a halt to the rising U.S. dollar and promote a coordinated devaluation in tandem with Europe and Japan.

In this case, however, the timing is reversed. Snow has attempted to implement a James-Baker style solution at the front end, promoting a decline in the dollar against the yuan that would ease Chinese imports, raise U.S. exports a tad, and greatly reduce protectionist and other impulses in Congress. In 2002-3, the Treasury Secretary has tried quiet diplomacy and been rebuffed. Enter the congressional dragon.

There are reasons to think this outbreak of trade resentments is stronger, not weaker, than the efforts against Japan and Europe in 1985-86, or the MFN-denial movement aimed at China from 1989 to 1994.

-- 1. The left is more focused. Human rights advocates have fewer totalitarian regimes to complain about, and with a Republican president, are in pure opposition mode. Their complaints about China, Tibet, slave labor, and political prisoners were muted during the Clinton presidency. They are rising now. Likewise, the anti-globalist left is still smarting from defeats over NAFTA and NAFTA expansion. China, compared to Mexico, is more distant and less pitiable, and is a winnable battle, especially given the possibility of center-right support.

-- 2. The corporate lobby is more divided. Software companies, aerospace manufacturers, and other exporters to China remain supporters of the regime, but have been cheated enough by Beijing on everything from office deals to lack of patent protection to grow suspicious. Meanwhile the ranks of domestic manufacturers harmed by China has grown. The bulk of big-business lobbying money and think-tank spending remains focused on uncritical assessments of the regime, and glowing hosannahs to the supposed ideopolitical benefits of trade. Its preponderance, however, has declined.

-- 3. The White House has fanned the forces of protection. This began with Karl Rove's strategy on steel, natural gas, lumber, and other special tariffs and quotas in 2001. The war may now widen to cover China, in light of Beijing's contemptuous dismissal of Snow. "Even a few months ago, those bills" on China trade "would have attracted a polite but firm statement of concern from Treasury," a White House political aide comments. "Now we're silent, and helping behind the scenes."

-- 4. The currency really is overvalued. It is difficult to find a parallel, from the last 100 years, of a country experiencing the kind of sustained trade surplus, capital inflow, and increase in official reserves, seen in China in the last 10 years, without a rise in the currency.

-- 5. China remains the leading arms merchant in the world. Beijing deals directly with such proliferation regimes as Iran, Syria, and Palestine, and with terrorist groups indirectly through its surrogates in Pakistan and North Korea. Economic forces aside, this is a full-blown scandal waiting to happen -- and one that will attract interest from both left (such as Nancy Pelosi) and right (such as Chris Cox) in the House and Senate.

The advent of congressional action against China, anticipated in this space all year, has begun. It now seems likely to include tacit, and in some ways active, help from the Bush Administration. It will last, at least, for months of agonizing uncertainty and growing recriminations between Washington and Beijing. It may even lead to the passage of a bipartisan proposal for tightening trade on China, one that will win applause from an unusual, but not inconsiderable, coalition of Naderites and neocons.

It's time to take profits and reduce Chinese exposure substantially, while keeping funds in rival India, which will benefit both from the economic and political heat on its rival. We even anticipate some turbulence for the U.S. market, suffering from the threat of a new "widening of the war" on trade. The primary victim of this effort, however, by a large margin, will be China itself. We're ready to buy back if the People's Bank withdraws from the brink and revalues the yuan -- but out for now.

(Gregory Fossedal is chief investment officer of the Democratic Century Fund, managed by the Emerging Markets Group. His firm may hold some of the securities mentioned his articles. Individual investors should contact their own professional advisor before making any decisions to buy or sell these or any related securities.)

In regards to Japan and the smaller tigers, the answer was to make sure they were prosperous so communism would be kept at bay.

Of course you're right about that, but this ceased being an issue for Japan by the late 1960's at the latest.

It doesn't explain our enormous trade imbalances with them for the past 30 years or so.

The problem is much deeper than we most of us care to admit - which is the concentration of huge amounts of wealth and power in a handful of gigantic corporations, the managers of which use soft money to buy off both parties.

In my humble opinion.

.....Bill Clinton made the strategic decision to cease trying to isolate the communists......

Not exactly......Richard Nixon and Henry Kissinger saw that moving China out of isolation could be beneficial. They were correct. Driving a wedge between USSR and China was to our benefit.

The current problems result from success. When the Chicaps feel comfortable playing the games of the big central bank nations, the situation will be resolved.

They hold our debt. They are holding ther bag..... the bag is empty!!

I don't think that this analysis is very good. I admit that I started to question the validity of his analysis when he noted that the yuan was pegged at 'about 8.5-1.' Now this is close to the truth but why hedge is it so hard to type 'about 8.2-1.' This is quibbling though so I gave him the benefit of the doubt and kept reading.

This analysis ends up much too soft on the current administration though. Snow mishandled this summit before he even arrived. I think everyone can agree that this problem is larger in relation to China than Japan but Snow visited Japan first. The Chinese since the end of WWII have been confused by the United States' actions in Japan. Why did the United States aid the enemy after WWII, rebuilding Japan, and allow China, the Ally, to fall further apart. By visiting Japan first Snow made this a matter of face. It is no wonder that he only was met by minor funtionaries like, "the top leadership at the People's Bank of China and the Finance Ministry." In Japan he was meeting with the President, who incidently ticks off every nation in Asia by visiting the shrine for Japanese soldiers every VJ-Day, not bank and treasury officials who only can do what the administration tells them to do and cannot make real decisions of this magnitude.

The author continues noting that an aide said the meeting was like a scene from Star Wars? Obviously this aide is bucking for a promotion from Snow with a little flattery. Please, this is ridiculous. Snow did not go over there as a tough guy and posing as one would be a charade that anyone would see through. At the same time this meeting was going on there was speculation that Bush needs and is going to ask for help in Iraq. In addition where was the recent summit with North Korea? The Chinese know the current administration needs their help and the administration is offering nothing in return. The Chinese, along with most of the rest of the world have been complaining about and fighting against Bush's steel subsidies. Almost since FDR started them the entire world has complained about farm subsidies but this hasn't changed either. And there does not appear to be any change on the horizon. In other words this administration really is not going to try to change anything.

The author is right, this is a major problem. As an earlier poster noted though, he is dead wrong about awakening a giant. The Chinese see this administration with its hand out and its head in the sand. This administration is not looking for agreement but a handout. On September 10th When asked about requesting troops and money from other countries Bush noted at a recent press conference that "I will once again make that plea." This statement came through to Beijing loud and clear they know what 'plea' means and guess who holds the IOUs and is ready to buy up some more. The sword isn't just dangling over this administrations heads it has already fallen and they just can't figure out where their headache came from.

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