In a report to the U.S. Congress released Tuesday, the Treasury Department declared that China’s fixed exchange rate system posed a risk to the Chinese economy and to the economies of major trading partners, and brandished the threat of retaliatory action. Although the report does not formally characterize the fixed exchange rate system as “currency manipulation,” the language used in the report represents a discernible “ratcheting up” of diplomatic pressure on the Chinese government on this issue. Specifically, the report states that “{c}urrent Chinese policies are highly distortionary and pose a risk to China’s economy, its trading partners and global economic growth.” The report urges China to implement changes “of a manner and magnitude that is sufficiently reflective of underlying market conditions.”
In response, the Chinese government reiterated its stance that its currency policy was a “sovereign” matter and that they will not be pushed into decisions by other governments. A senior Chinese official was quoted as stating that the United States should “put its own house in order before blaming others” for its trade deficit.
The U.S. trade deficit with China reached $124.9 billion in 2004, larger than with any other country, and representing approximately one-fourth of the last year’s trade deficit of $617 billion. China is also one of our largest foreign creditors, holding more than $600 billion in Treasury securities and other dollar-denominated instruments as it seeks to keep the yuan pegged to the U.S. dollar at an exchange rate of 8.28 yuan to the dollar.
Under U.S. law, if a country is determined to be engaging in currency manipulation practices that provide a competitive advantage, the Administration is required to enter into negotiations that could lead to the imposition of retaliatory measures. Yesterday’s report implicitly provided China with a five-month period - i.e, until October, when the next Treasury report is due – to implement changes to its exchange rate system.
However, Congress may not be that patient. Increasingly concerned about the economic and political ramifications of this country’s soaring trade deficit, several bills have been introduced that would impose punitive tariffs on all Chinese imports. One of these bills, sponsored by Senators Charles Schumer (D-NY) and Lindsey Graham (R-SC) would impose tariffs up to 27.5 percent on all Chinese imports if that country failed to change its currency policies. That bill gained a bipartisan 67 to 33 vote earlier this year on a procedural matter, but Senator Schumer agreed to delay further action on the bill until July, when Senate Republicans have agreed to allow a vote on the substance of the legislation. This would significantly “tighten” the window of opportunity for the Chinese government to act in a manner that will placate Congressional critics.
Many economists believe that the yuan is undervalued by about 40 percent. However, many economists also believe that an appreciation of the yuan – in the range of about 10 percent from its present value, which is about the most observers can expect in the short term – would do little to reduce the overall trade deficit. Many economists also believe that a significant appreciation of the yuan could result in an increase in U.S. interest rates, since the Chinese government will not then need to purchase as much in Treasury and related dollar-denominated securities. In a real sense, at least on a “macroeconomic” basis, a yuan that is allowed to float freely on world currency markets may have both a beneficial and detrimental impact. For specific U.S. industries and for specific imported food products, it may ameliorate the significant competitive advantage that the fixed yuan now allows.
We will continue to track developments closely, and keep the Association advised.
