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Issue 04, 2007 (15 February)
 U.S. Lawmakers Continue to Scrutinise China's Exchange Rate Policies

There has been plenty of activity in the halls of Congress during the first six weeks of the year regarding China's exchange rate practices. Although nothing concrete has yet come of these efforts, it is becoming increasingly clear that China's bi-lateral trade deficit with the U.S. and the valuation of the yuan are likely to receive as much attention from Congress in 2007 as they received in 2006, if not more.

Legislators have already introduced a number of bills designed to tackle China's alleged undervaluation of the yuan. The most recent effort involves legislation introduced by Reps. Duncan Hunter (Republican-California) and Tim Ryan (Democrat-Ohio) that would define currency manipulation as a countervailable export subsidy and would establish guidelines that the U.S. International Trade Commission would have to follow to determine whether currency manipulation has occurred. The legislation has collected 44 co-sponsors and awaits consideration by the House Ways and Means Committee. This is at least the third piece of legislation introduced in Congress this year that deals specifically with currency manipulation.

Separately, the Senate Banking, Housing and Urban Affairs Committee held a hearing 31 January on the Treasury Department's report to Congress on international economic and exchange rate policy and the U.S.-China Strategic Economic Dialogue. Committee Chairman Christopher Dodd (Democrat-Connecticut) kicked off the hearing by painting a fairly grim picture of the performance of the U.S. manufacturing sector in recent years and the negative impact of that performance on the average American family. Dodd argued that China is a very significant cause of the decline in U.S. manufacturing employment and has also made a substantial contribution to the record U.S. trade deficit with the world. China's manipulation of the yuan, according to Dodd, is a vital challenge that needs to be addressed if the U.S. government is to ensure a level playing field for U.S. companies.

While the pace of the yuan's appreciation has quickened, added Sen. Chuck Schumer (Democrat-New York), China's currency remains significantly undervalued as a result of "deliberate intervention" by Chinese authorities. According to Schumer, China "could do more and should do more" to revalue the yuan, and he claimed that the Bush administration has "not been pushing them hard enough." Schumer admitted that he "ruffled a few feathers" last year with legislation that would have imposed a punitive 27.5 percent duty on all imports from China unless Beijing took steps to revalue its currency, a measure widely held to violate WTO rules. He stated that he is now willing to work on WTO-compliant legislation, but he also warned that "if the pace of progress does not pick up, and more market reforms are not accomplished in the currency arena, then bipartisan legislation will pass the Congress that will put the President in an uncomfortable position."

Treasury Secretary Henry Paulson countered that the administration is actively pressing Chinese authorities to introduce greater currency flexibility and undertake wider market reform. While China has made considerable progress since it abandoned its pegged exchange rate in July 2005, the administration still believes that China is not moving fast enough. Paulson declared that a major goal of his final two years as head of the Treasury Department will be pressing the Chinese government to move toward a full-fledged floating exchange rate regime. According to Paulson, this end result involves several steps: (i) the Chinese government should progressively widen the band that limits the daily movement of the exchange rate; (ii) the central bank should progressively reduce its intervention in the foreign exchange markets; (iii) China must develop the fundamental components of a capital market (a bond market and a yield curve) to absorb inflows and outflows of foreign exchange and provide ways to hedge against exchange risk; and (iv) the central bank must set clear policy targets to avoid inflation and thereby provide confidence in the value of the yuan.

In response to Chinese concerns that there is risk in moving too quickly, Paulson has advised Beijing that there is greater risk in moving too slowly because the international community could run out of patience if reform does not proceed at a more hurried pace. Paulson also re-stated his belief that currency reform will not by itself significantly reduce China's trade surplus. In his opinion, China needs to restructure its economy so that consumer demand replaces exports and excess investment as the country's engine of growth.

In related news, Senate Finance Committee Ranking Republican Chuck Grassley recently announced that he is working with Committee Chairman Max Baucus with a view to holding oversight hearings on U.S.-China economic relations in March. The hearings are likely to cover China's exchange rate policies, among other important issues. These two senators are expected to develop a middle-of-the-road legislative package to address perceived failings on the part of China and lessen congressional appetites for more extreme alternatives.