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The Dreaded M-Word - Once China Is Declared A Currency Manipulator, What Next?
On April 15 the Treasury will issue its report on International Economic and Exchange Rate Policies. Following a massive push by politicians and economic pundits alike, the probability that China will be branded a currency manipulator is extremely high, if not certain. Following the last few days of adverse developments in the Google censorship saga, it is unlikely that China will accept that particular title with a wink and a smile. And while China was previously named a currency manipulator in the past, the last time this occurred was in 1994. To say that a lot has changed since then is an understatement. What happens after April 15, 2010 is anyone's guess, although for some perspective of the bullish cash, here is Goldman with their range of expected consequences. Of course, what is good for Goldman is bad for Goldman's clients so keep that in mind, especially since this is a sell-side piece.
1. Overview
Pro-cyclical assets started the week with a more constructive tone after some weakness towards the end of last week. Equity markets and oil rallied moderately and copper made new highs. In FX, Asian currencies continue to trade relatively firmly, helping our long Asia basket vs Yen trade. The AUD was given an extra boost with increased expectations of a rate hike in April. We have tweaked our expectations for RBA tightening and now expect the bank to hike rates to 5.75% by Q3 2011 from 5.5% previously. Within the details we now expect a 25bps rate hike at next week’s meeting (brought forward from May) and have added another hike in June. At around 5.80%, Australian 10-yr government bonds already trade at top of the range in place since last October. Fixed income markets remained largely range bound ahead of the upcoming month-end and Easter holiday. Greece issued EUR5bn worth of new 7yr bonds but demand was not overwhelming.
In terms of macro news, German inflation data surprised on the upside - mainly due to energy prices. Pan Eurozone core inflation continues to decline. In the US, monthly income and spending data suggest that consumption growth continues to outpace income growth and the monthly household savings rate has declined back to 3.1% of disposable income. The core deflator of personal consumption remains on a downward trend.
On schedule today, the Case Shiller Index for January with consensus calling for a decline of -0.6% yoy vs -3.1% previously. The March Conference Board index of consumer confidence should rebound notably as neither the Michigan nor ABC indices confirmed the surprising drop recorded last month. We are forecasting +56 vs previous of +46.
In largely becalmed currency markets, the focus is growing on whether the US will name China a currency manipulator in the semi-annual Treasury report on FX.
2. More focus on the Treasury FX report than in a long time
In the last couple of years, the semi-annual Treasury report on International Economic and Exchange Rate Policies was an important fixture for FX markets, in particular before China revalued the Yuan in 2005. However, when the CNY started to appreciate at a faster pace since mid-2006 some of the attention disappeared.
When China re-pegged $/CNY in mid-2008 the focus remained muted initially. Initially that was simply because a pegged CNY was a one of the smaller issues during the financial crisis. Moreover, the trade weighted CNY continued to appreciate strongly on the back of USD strength. Subsequently China played a leading role in the G20 and was widely commended for its anti-cyclical fiscal policy, which easily outweighed the already re-emerging concerns linked to the new peg.
But now, after further post-crisis normalisation and in light of the ongoing weakness in the US labour market, the political focus on China has started to grow notably. And the upcoming report crystallises this focus, as so often in the past. The next instalment is due on April 15. The Obama administration met the deadline for previous reports in 2009, though under the Bush Administration delays of about a month were customary. Given that US and Chinese officials are scheduled to hold their Strategic and Economic Dialogue (SED) talks in May, the Treasury may opt to delay the report past the deadline.
3. What comes after the M-word?
One of the more interesting facts about the semi-annual report is the legal implication of labelling a major trade partner a currency manipulator. According to the Omnibus Trade and Competitiveness Act of 1988, the administration “shall seek to confer and negotiate with other countries” to achieve better macro policy coordination, more sustainable external balances and develop a program to improve the “functioning of the exchange rate system”.
In other words, if the Treasury finds that China is manipulating its exchange rate, the Administration will have to engage with China, which is exactly what has been happening for years. Even on the website of the Treasury’s Office of International Affairs a link to the semi-annual report is located next to a link to the US-China Strategic and Economic Dialogue.
4. Interplay between US and Chinese politics
As explained in the previous section, branding China as a currency manipulator could put the Administration in an uncomfortable position of having to do more of the same. The fact that the word “manipulation” is fairly strong and with a clear negative connotation suggests many China critics would not be satisfied by just more talk. In the past there have been several attempts in Congress to introduce punitive legislation related to China trade. Using the M-word without being backed up by tougher policy could increase frustration in Congress and hence accelerate the process of imposing tariffs. That legislative pressure has already begun to increase, with Senators Schumer and Graham pressing for a vote on their legislation by the end of May.
On the other hand, not labelling China a manipulator when a majority of observers hold the opposite view may have the same frustrating impact, particularly when the unemployment rate stands at close to 10% ahead of mid-term elections. The fact that China is actually making substantial progress towards adjusting the imbalances, mainly through strong domestic and import demand, seems to attract very little focus in US policy circles. One possible compromise would be to decline to name China in the report, but for the administration to take action on a related issue. Such a related issue could be a high-profile decision on a trade dispute, as highlighted by Alec Phillips in Washington.
The outcome of the report may therefore matter less than public opinion relative to China trade, which seems broadly represented by the pressure from Congress. Still, the semi-annual report remains important because it reliably puts the subject on top of the political agenda every six months and helps gauge the political temperature on China related issues.
And this process and related pressures do actually seem to yield some results.
For example, after the initial 2005 appreciation not much happened in $/CNY for about nine months. And despite coming under intense criticism Treasury Secretary Snow did not label China a currency manipulator in May 2006. Less than a week after the release of the report $/CNY broke below the psychological level of 8.00 after having stalled a whisker above that level for some time. 6 months later, before the next report, $/CNY had dropped by another 1.5% - maybe a pure coincidence linked more to Chinese inflation pressures at the time than US politics, but it was also becoming clear just how strong protectionist sentiment had become again. Moreover, volatility in $/CNY increased following the May 2006 report and stayed notably higher until the Chinese re-pegged during the crisis.
In recent years there has always been a hint of good-cop-bad-cop, where the semi-annual report only partly manages to contain the protectionist threat from a group of influential lawmakers. The current situation resembles past patterns. Once again the US Government is under pressure to act on China and without any concessions from Beijing, the probability of Congress imposing tariffs could go up substantially.
5. Market impact – Watch Asian currencies
The likelihood of China moving in response to the rising US pressures is clearly rising in our view, though the timing does not have to coincide with the semi-annual report. The legislative schedule in Congress may be equally important.
Moreover tighter monetary policy, including via marginal FX appreciation, appears necessary in any case to prevent China from overheating as our Asian economics team have argued consistently. Just how strong demand is currently in China, will likely be illustrated by the next trade numbers, due before the release of the report, around April 10.In terms of magnitude, we would assume China’s policymakers would prefer a gradual drift, more consistent with a gradual tightening of financial conditions. But compared to the risks of punitive US legislation, the risks of a one-off move on the currency may be more manageable as Mike Buchanan has pointed out. Therefore, the chances seem to be increasing for a one-off move, just big enough to appease political pressures in the US. The question really is how small such a revaluation can be so that US policymakers can still credibly point to a success and move on to other subjects.
Such a move does not have to be big, partly because it is very clear that punitive import tariffs would hurt the US as well. For example, the U.S.-China Business Council, whose roughly 220 members range from aircraft manufacturers to dominant discount retailers, has called for calm according to Reuters. Financially stretched consumers would notice if garments, toys and electronics from China suddenly cost a lot more. And there is also the fact that a trade war raises the spectre of foreign central banks selling US Treasuries (an outcome we deem unlikely but which may unnerve the market all the same).
Should the Chinese Authorities therefore decide to revalue, a relatively small move of 5% or less would likely be sufficient. Such a move would have little measurable impact on the real economy. In fact the trade weighted Yuan has been trading in a 15% range since the currency has been re-pegged in July 2008, mainly due to the huge swings in the Dollar during that period and currently stands in the middle of the that range.
The true economic impact of such a relatively small move is likely limited and difficult to identify. As an example, just think of the net impact on Chinese exports of a 5% CNY move, and over what timeframe the trade balance would be affected. The elasticity to FX is likely small relative to other factors like re-emerging domestic demand in developed countries. Consequently the impact on most asset classes, including those affected by Asian reserve accumulation, would likely be very small as well.The only clear impact would likely be for other Asian central banks, which would gain scope to let their managed currencies appreciate more in face of mounting inflationary pressures. This is something we are positioned for via our Asian basket recommendations long MYR, IDR, INR versus JPY.
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It's funny how this only matters in a floating rate system. Which is arbitrary on its own.
We don't want china to float, we want everyone to model them and have a fixed one.
So....we all decided to let monetarists screw us, but not you. So it's YOUR fault, we're all broke. The steps you are taking, which are asinine, but doing it for us, aren't enough.
Nice diplomacy. I'm sure things will get off on the right foot.
short the dollar, naturally
If I were them I'd devalue instead.
nothing will happen.
Yeah we need to piss in China's rice bowl...so anyone on the Hill realize they are our biggest creditor? Usually not the best gambit to piss off the biggest creditor when engaging in a massive increase in deficit spending. But what do I'm know, I'm not an government official.
Why to I get the feeling we are getting pushed into a trade/currency war with China and a new East-West Cold/Hot war?
I'm again reminded of the movie "Blazing Saddles" where the sheriff puts the gun to his own head. Only in this case, I guess it's the old sheriff putting the gun to his head, telling the new one to stop loaning him money, because its making it harder for him to pass bad checks.
Mongo not know, Mongo only pawn, in game of life.
I hope this desperate push to finger a scapegoat will prove both futile and to be the US monetary policy's undoing.
China, manipulating their currency? Pot, meet kettle.
Why are these sht heads playing with fire?? I mean way to go...!
I wonder what China is doing between now and the 15th to prevent this.
Basically if this passes the US will have the right to levy import duties on Chinese goods.
A stare down? We have to remember if we accuse them of currency manipulation right or wrong we are insulting them. So they will have to respond to save face. I doubt their government will roll over and take it, pride will force an action to an "insult" by the USA. What it could be I don't know, but we could see anything from them insulting us back and nothing to an increased unwinding of China held dollar denominated assets.
So I don't know if the Chinese are doing anything to prevent this as what can they do? If they knuckle under now it looks like they caved to US pressure and loose face among their people. Like I said I'm guessing the plan is for them to stare us down and see if we blink and if we up the ante, they up the ante again.
As long as they were buying our treasuries we looked the other way. If they aren't buying our debt then this is one way we have of pointing out the downside on not "sharing the burden" of all the profits they've made buy stealing IP and counterfeiting US products.
But being branded as a currency manipulator by their largest customer is not something they're passively waiting for. That's why they have huge lobbyists like Patton Boggs taking our legislators to lunch.
Schumer is introducing legislation to smack China with tariffs if they continue to peg the yuan as most of you know. He was in upstate NY yesterday and said that the Chinese might get mad about this and his quote in response was "You know what I say? Too bad."
Classic protectionism continues to bubble up.
I still think the US will wimp and not call China a currency manipulator. If I'm wrong, we ought to get some fireworks.
jeez. That sounds as smug and shoulder-chippy as Obama's "I say, go for it" comment about various legal challenges happening around the country to the 'health care' bill. Our federal government really needs to be taken down a notch or two or fifty.
What's "ALL YOUR BASE BELONG TO US" in Mandarin?
yi nide shi guishu wo!!!
....well... sort of
"...AND WOMENS..."
China will not have to do anything it does not want to do. The American people do not believe anything Obama, the Treasurer, Congress, bankers, economists, say or write. The lying has reached a point in this country that accusing China of being a currency manipulator is nothing more than another lie of the Obama administration.
The US is going to have a tough case to make. The Yuan is linked to the dollar. So the Yuan just revalued against the Euro by 10%. China will announce a trade deficit soon. Hard to beat up a "manipulator" with those issues out there. If this was a game of chess I would say that the US lost the Bishop.
This is a game of chess.
I agree with that assessment; however I'm sure that US lawmakers are dumb enough to ratchet up the rhetoric anyway.
The flip side is that any hint of a trade war and equities will get blasted; therefore I think they will do everything possible to keep the tone cordial or extend and pretend the current state of suspended animation.
So I wonder if the treasury lashing last week was at least partially due to China dumping supply on the market?
So let's think this through: You're suggesting that a trade war will blast equities...
Blasting Equities forces flight to UST paper...
Keeps rates in check... (for a little while)
Gives China a solid exit for their UST...
Thinking about it in those terms tells me you have a pre-made agreement to engineer a "situation" to help China and the UST out (short term of course). We have a scapegoat that makes out like a CDS trader on Greece, etc.
You get an A+
Thanks - but it only works if all the actors play along. People mentioning chess are right, unfortunately it's more complex (multiple dimensions, parties - not two). It's why I like Mensa logic games; too bad my youngin beats me at them (no, I'm not kidding).
The cost of Chinese goods will go up... contributing to inflation... which will put the squeeze on Bernanke.
The bet here is that China will be more affected by the loss of revenue than we will be by the loss of merchandise.
The more reason to bet against China given that they're barely able to hang on to what they have. If they collapse, it will be hard and semi-permanent.
Except that China is more in danger of losing its King. A bishop might be expendable, but China is going all-out to kill off its pawns, rooks, knights, and bishops to defend its royalty.
If the US loses its bishop, that's usually about the depth of its losses.
It would be nice if these congress-criminals would show this much concern about the manipulation in the precious metals markets. But of course China doesn't sweeten the campaign pot like JPMorgan does.
If China is labeled a manipulator does that mean everyting in the Dollar Store goes to $1.25 overnight. Trade war? Bring it on. Who needs their crap? Maybe we'll learn to make shit again in this country
Unlikely, since US taxes and regulations have destroyed our industrial base, and will continue to oppress it for the foreseeable future.
Ayn Rand said something about a barbarian chaining a farmer down, pillaging the land, taking the water and ruining the soil, and then demanding that the farmer produce food for him. This is that exact situation. Mr. China across the river has been kind enough to supply us with food in exchange for IOUs, but the Barbarian has "gotten wise" to that, and will now demand that a tax be paid by Mr. China for the right to supply food for nothing. Mr. Barbarian thinks this is a good idea, because Mr. Farmer is only poor and broken because mean Mr. China is is making all of the food for him.
Yet no-one seems to be able to understand that the whole mess is the fault of Mr. Barbarian, the US government.
The problem is that people use Rand to justify dragging others into their personal holy war.
Holding existing jobs and future opportunities hostage/going offshore until you have the desired political outcome is a problem not of the government's making. The person(s) who decide to go on that path are responsible for the damage they wish to cause.
When you decide to go offshore or wait out the government, people pay - the government doesn't.
I makes a difference what we're talking about manufacturing. A plant to crank out US-made rubber flip-flops wouldn't take long to start or involve a lot of capital risk. But for serious goods like DVD players or flat-panel TV's, well I wouldn't invest unless I was confident there would be at least 10 years of economic health and rational markets, because the startup costs (including training a workforce) would be immense.
Keep in mind that there has never even been a consumer VCR made in this country, even though we invented videotape technology.
Um, more manipulation?
Bring it on.
China needs a humbling.
You give the impression that China is made up of bunch of morons and that only by the grace of God and the US are they capable of making anything or selling anything. Your chess analogy earlier made my head explode. These people have been playing GO for centuries and know Sun Tzu back to front.
But beyond those useless metaphors, while the US was partying prior of the collapse of the economy, and especially since then, the Chinese have been buying resources and making trade and development agreements all over the globe, especially in Africa and S. America. Increasingly, these deals are made in RMB. They have bumped the US as Japan's number 1 trading partner. And, since they have no political restrictions, they trade heavily with countries off limits to US companies. Ergo, they have a growing consumer base outside of the US.
But let's say that a trade war does ensue and China has to retrench (which they will do rather than accede to US demands, IMO), the generations of the MAO era are still around, not that they want to return to that lifestyle but only that they realize it is doable for the right cause. Enter the US, who, under Obama's ham-handed diplomacy, is setting themselves up as the perfect enemy for the CCP to rally a very, very patriotic people around. Get it? They can hold out a lot longer with many more options than the Obama administration.
One more thing the Chinese know is history. The last time the US was in a currency mess, it strong-armed Japan and several European countries to strengthen their currencies to bail out the US. As a direct result of this the Japanese economy exploded in a bubble and collapsed. Neither the Yen nor the Japanese economy has recovered. For the Chinese, they see the US in the same situation and are simply not willing to kneecap their economy to bail out the wasteful actions of the US. Given this, neither would I.
But beyond those useless metaphors, while the US was partying prior of the collapse of the economy, and especially since then, the Chinese have been buying resources and making trade and development agreements all over the globe, especially in Africa and S. America. Increasingly, these deals are made in RMB. They have bumped the US as Japan's number 1 trading partner. And, since they have no political restrictions, they trade heavily with countries off limits to US companies. Ergo, they have a growing consumer base outside of the US.
You're presuming that the US can't/won't make more "accidents" happen in that part of the world. The US has the capability to make things very painful for those countries that accept Chinese help. All they have to do is help a known terrorist and be called on it.
But let's say that a trade war does ensue and China has to retrench (which they will do rather than accede to US demands, IMO), the generations of the MAO era are still around, not that they want to return to that lifestyle but only that they realize it is doable for the right cause. Enter the US, who, under Obama's ham-handed diplomacy, is setting themselves up as the perfect enemy for the CCP to rally a very, very patriotic people around. Get it? They can hold out a lot longer with many more options than the Obama administration.
That would only make things worse for China as it would trigger things none of their lobbyists could fix with campaign cash. It would trigger a patriotic US response in kind, making the situation worse.
You assume that China is in more stable of a position than the CPC would be willing to disclose. The way their country is setup, it is too easy to cause regime-collapsing disorder. Deny them a destination for their junk-grade goods and slave-labor services and they won't be able to disappear enough people.
WOW. That's hardly worth a response.
The way their country is setup, it is too easy to cause regime-collapsing disorder.
A totally mind-numbing lack of knowledge on your part. And I am trying to be nice.
China cares not a bit about this, officially or unofficially. Bemusement, perhaps.
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