Currency questions intensify between US and China

Trade agreements require trust - confidence that both sides will live up to the terms of the deals and play fair.

Now, the fabric that holds together the US trading relationship with China is being pulled and stretched. Because of the importance of these two nations, how the tensions play out could affect both the global economy and the climate for expanding trade.

The Bush administration has become increasingly vocal about the differences with China and recently capped some of its apparel imports. Congress is considering a bill to put tariffs on Chinese-made products if China doesn't revalue its currency. Business groups are also lobbying for change, and last week Treasury Secretary John Snow said he expected China will make some change to its currency over the next several months.

But behind the new signs of urgency, economists caution that a revalued yuan is no cure-all for America's wide trade deficit with China. For example, Federal Reserve Chairman Alan Greenspan said last week that the US trade deficit wouldn't come down due to a revaluation, since other countries with low labor costs would make the goods instead.

That apparently has not stopped the administration from pushing ahead. Wednesday, Sen. Charles Schumer (D) of New York, who has sponsored legislation to punish China for currency manipulation, noted at a Monitor breakfast that a high Treasury official told him the legislation was helping in dealing with China.

According to the Tuesday edition of the Financial Times, the US Treasury has informed the Chinese it must revalue its currency by at least 10 percent to defuse tensions with Congress. It also says that the US is using private citizens such as Henry Kissinger and Brent Scowcroft to communicate with the Chinese.

A Treasury spokesman did not return phone calls to the Monitor.

Some international observers question whether private individuals should be used to communicate with the Chinese. "The Treasury secretary is perfectly capable of calling the Chinese," says Robert Hormats, vice chairman of Goldman Sachs International. "I question how appropriate it would be to ask a private individual to suggest what an exchange rate would be."

Dean Baker, co-founder of the Center for Economic and Policy Research in Washington, says the administration is aware of the downside of a rising Chinese currency: Import prices and interest rates may rise. US consumers have benefited from being able to buy lower-cost clothing, electronics, and other goods. At the same time, China is currently investing about $1 billion a day in the US.

"China is handing us hundreds of billions [through their investments in US Treasury securities] to buy their stuff," says Mr. Baker. "At some point they might want to use that money."

If that were to happen, he warns, "It might not be a pretty picture: The housing bubble could burst," because interest rates would be higher.

Still, the business groups that are urging President Bush to act don't want the administration to stop at a currency revaluation (which they think should be as high as 40 percent). They maintain that China's system is opaque, hiding subsidies and loans provided by the Chinese government.

"We need to know what other subsidies the Chinese would increase, even assuming they did revalue upward," says Alan Tonelson, a research fellow at the United States Business and Industry Council in Washington.

If the Chinese do revalue their currency, he thinks the biggest winners will be small and medium-sized US manufacturers, especially in the metal-bending, cutting, and forming industry. "They are able to compete on quality and innovation," he says.

Yet even if China does revalue the yuan, some analysts are not convinced it will make much difference. Jay Edward Simkin, an international economist, thinks if China revalued by 25 percent, Chinese companies would simply accept lower profits to hold on to their market share. Then, he says, they would cut wages or find other ways to cut their costs.

If the Chinese tried to lower labor costs, he envisions the possibility of social unrest that he fears might destabilize the banking system. "We know from many other cases that banking-system crises have deep consequences for the country in which they occur and global impacts," says Mr. Simkin, who produces a report entitled "RiskAlert!" in Nashua, N.H.

If the US is going to force the issue with the Chinese, economist Clyde Prestowitz wonders why the US won't go after Japan, which also intervenes to prevent the yen from rising against the dollar. "Why not Japan? It's the bigger economy," says Mr. Prestowitz, author of the new book, "Three Billion New Capitalists: The Great Shift of Wealth and Power to the East."

To businessman Brett Kingstone, CEO of Super Vision International, the problem isn't the currency, but the violation of intellectual property rights. Mr. Kingstone is author of the book "The Real War Against America," which details how the Chinese allegedly stole his blueprints, chemical formulations, and trade secrets for his fiber-optic business. He has won court judgments against the alleged instigators and obtained court orders seizing Chinese products that use his technology and are shipped to this country.

"I think there's too much attention paid to the currency issue," he says. "It would be immaterial if China does not make significant reforms and eliminate the rampant piracy its been practicing for decades."