Remember The Whole "China Is A Currency Manipulator" Brouhaha? It's Back

One of the parallel news lines that was buried in last week's oil spill, was the pick up in Chinese currency manipulation rhetoric (with the Treasury now two months behind its April 15 deadline on determining if China is an FX manipulator, indicating just how terrified of an adverse response Geithner truly is), particularly that by Chuck Shumer, whose most recent proposal is not to vote China off the face of the manipulative planet (yet all China does is peg its currency to the dollar, which is kept at its level by US Fed monetary policy - does that mean that the Fed is a currency manipulator too?), but to effectively change the entire concept of "currency manipulation" and rebrand it to "currency misalignment" thus reducing the risk of political fallout. Couple this with several complaints received by the Dept of Commerce from domestic manufacturers alleging Chinese subsidies, and the Chinese FX relations, now that global liquidity is assumed to be once again "under control",  may once again deteriorate rapidly. Attached is a succinct summary from Goldman's Alec Phillips which present the key issues in the upcoming weeks over the China currency manipulation situation.

  • Rhetoric out of Washington regarding US-China trade relations is likely to ramp up over the next few weeks. The most important issue is the possibility of Senate passage of Senator Schumer’s proposal to apply trade remedies as a response to undervalued currencies among trading partners.  A possible decision by the US Department of Commerce on whether to consider currency undervaluation a trade subsidy under US law and the Treasury’s semiannual foreign exchange report also look likely to come up this summer.
  • This latest round comes at a more sensitive time and could be more significant than previous flare-ups in US-China trade relations. As we’ve noted in the past, trade tensions tend to rise along with the unemployment rate, but so far the use of trade remedies—antidumping and countervailing duties—has barely risen from the cycle low reached in 2006.  While most market participants have dismissed the rhetoric of the last few years as inconsequential, rising tensions combined with elevated unemployment could be a more dangerous combination. 

Rhetoric out of Washington signals rising trade tensions. While ultimatums on trade policy out of Congress are nothing new—lawmakers have been focused for several years on China’s foreign exchange policy, which many US manufacturers, labor unions, and others see as a source of unfair advantage—the latest round takes place in a more sensitive environment. The last heated debate over US-China trade (and specifically foreign exchange) that took place in 2005 and 2007, a fairly benign environment with reasonably strong growth and relatively low unemployment.  As rhetoric heats up once again, the extremely high level of unemployment and underemployment in the US labor market could make lawmakers even more sensitive than usual to claims that China’s foreign exchange policies are impeding US economic recovery.

The exhibit shows the annual unemployment rate against the customs value of imports subject to antidumping and countervailing duties approved in that year. Although these trade remedies are fairly routine—dozens of petitions are filed each year—their frequency provides an easy way to track the ebb and flow of trade policy shifts. Not surprisingly, US trade remedies have increased significantly when the unemployment rate was rising, signifying an increasingly protectionist stance during those periods.

What is surprising, however, is that there has not been a more significant reaction thus far in this cycle.  Given the prolonged policy reaction over the last two years—first through financial stabilization, then fiscal stimulus, and now financial reform legislation—lawmakers may have simply focused their attention on other issues this time around.  That said, if the unemployment rate remains essentially unchanged over the next year as we expect, it is very possible that policymakers may finally react, albeit after a longer than usual delay.

US Unemployment and Trade Remedy Actions

The main source of friction is China’s foreign exchange policy, as it has been for the last few years.  Most US policymakers appear to believe that the Renminbi is undervalued against the dollar, particularly in Congress. After a respite during the financial and housing crisis in 2008-2009, rhetoric has begun to heat up, with several potential developments over the next few weeks:

  1. Sen. Schumer’s legislation—a vote in the next two weeks?  The primary focus is Senator Schumer’s (D-NY) legislation, which is similar to proposals introduced in previous years. His most recent proposal, introduced in March, would (1) require the Treasury to report semiannually on currency “misalignment” rather than “manipulation,” which makes it more likely that the Treasury would find a currency misaligned but potentially lowers the political fallout from doing so; (2) incorporate misalignment into antidumping duty calculations; (3) prohibit US government purchases of imports from that country, unless the country is party to the Government Procurement Agreement (GPA, see below); (4) require the Department of Commerce to initiate investigations into currency misalignment as a subsidy if a domestic company requests it; (5) request consultations through the IMF, and (6) require the administration to bring a complaint in the WTO if the trading partner hasn’t adopted policies to remedy the misalignment.  Senator Schumer may have some cooperation among Democratic leadership in bringing this bill to a vote in the Senate, most likely as an amendment to an upcoming small business package that could be considered next week. if the bill does come up for a vote it is likely to pass in the Senate, though whether it becomes law or not will depend on House passage. For his part, House Ways and Means Chairman Sander Levin (D-MI) has not been as strong an advocate of legislative intervention in US-China trade relations.
  2. The Commerce Dept.’s decision on currency-related trade remedies.  The US Department of Commerce has received several complaints from domestic manufacturers alleging that imports from China are subsidized by the undervaluation of the Renminbi against the dollar. Thus far, Commerce has declined to initiate investigations of this aspect of these cases, due to the “unique nature” of currency undervaluation as a trade subsidy and the methodological issues involved, but has come under increased pressure from members of Congress to make a determination on the issue. A determination that currency undervaluation is a countervailable subsidy could take some pressure off of the Treasury’s upcoming foreign exchange report (see below), but only temporarily.
  3. Treasury semi-annual report on foreign exchange.  The report, in which the Treasury must declare whether any country has manipulated its currency, is unlikely to be published until after the upcoming G-20 leaders meeting on June 26-27, more than two months past the congressionally mandated April 15 deadline.  At this point it isn’t clear when the report will come out; Treasury Secretary Geithner indicated in congressional testimony last week only that it could be delayed past the G-20 meeting while the administration takes stock of the situation. Although a delay of more than two months past the deadline may seem unusual, in the early days of this report following the establishment of the Treasury’s reporting requirement in 1988, delays of several months were common. Nevertheless, the next reporting deadline the Treasury faces is October 15, 2010, and most observers believe that the last report must, at a minimum, be released before the next one is due.

Although the ongoing dispute over currency valuation has received the most attention from the market and from lawmakers, two other issues are rising in importance among US policymakers. First is China’s “indigenous innovation” rule, which grants government procurement preferences to products that use intellectual property developed and registered in China, similar to the various “Buy American” proposals which require certain purchases be of goods made in the United States.  Sen. Stabenow (D-MI) has introduced legislation that would prohibit US government purchase of Chinese products or services until China has signed the GPA, which US lawmakers hope will reverse current Chinese rules on “indigenous innovation,” Although this issue has not had the same high profile as the currency issue in the political debate thus far, it is fast becoming a significant source of concern for US policymakers; the US International Trade Commission will hold public hearings on the issue this week, which could generate additional attention on the issue as well.

A second issue that has emerged lately is a focus on the risks to US security from foreign holding of US debt. Last week the Senate approved an amendment that would require the Treasury to report quarterly on foreign holdings of US debt and to determine whether any country’s holdings posed a national security risk.  This proposal appears aimed mainly at curbing federal spending rather than influencing international purchases of US Treasury debt, and it seems unlikely to have major ramifications.  Still, there is irony in the prospect of Congress requiring an additional politically sensitive periodic report from the Treasury, as it awaits the first one on foreign exchange.


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