China's Inflation May Ease Pressure on Yuan at Hu-Obama Summit

Rising inflation in China that is causing headaches for President Hu Jintao at home may help relieve tensions with the U.S. over the yuan as he prepares to meet President Barack Obama in Washington next week.

Prices are climbing faster in China than in the U.S., making Chinese goods less competitive, Treasury Secretary Timothy F. Geithner said this week. Chinese officials may also seek to speed up gains in the currency, also known as the renminbi, to fight inflation, lowering the cost of imported U.S. goods such as Boeing Co. aircraft and Microsoft Corp. software.

Hu may seek the easing of a U.S. ban on technology exports, while Obama is likely to focus on access to Chinese markets, lower subsidies for companies and cooperation on North Korea. Meantime, the U.S. economic recovery and new Republican leaders in Congress who don’t see the yuan as a priority may also help make the issue less contentious, said Michael Paulus, who heads the Asia Public Sector Group at Citigroup Inc. in Hong Kong.

“That the renminbi is starting to get on a track that people feel somewhat comfortable with takes it off the front burner,” former Treasury official Paulus said in an interview. “The people at the White House and the Treasury and elsewhere will not try to downplay it, but not play it up either.”

Geithner, speaking in Washington on Jan. 12, said that while the yuan was still “substantially undervalued” the “fundamental forces that are pushing Chinese productivity growth and are pushing inflation higher will bring about the necessary adjustment in exchange rates.”

Factoring in rising prices, the erosion of Chinese companies’ advantage over U.S. rivals was equivalent to the yuan strengthening at an annual rate of about 10 percent, he said.

Trading Range

The yuan’s trading range, set each morning by the People’s Bank of China, is increasingly linked to political events between China and the U.S. Shares in the exchange-traded, New York-based WisdomTree Dreyfus China Yuan Fund gained 3.1 percent in the month leading up to a scheduled Oct. 15 release of a Treasury report on whether China manipulates its currency, which was delayed. Shares fell 1 percent over the next two weeks. In the first three days of this week the fund gained 0.51 percent.

Last year Obama and Congress pushed China repeatedly to speed up yuan gains amid historically high unemployment. The jobless rate reached a 26-year peak of 10.1 percent in October 2009, and is now at 9.4 percent.

Obama said after meeting Hu in November that China is spending “enormous amounts of money” to keep the yuan undervalued. Democrats in the House pushed through a measure, which never saw a vote in the full Senate, making it easier for U.S. companies to seek penalties against Chinese imports because of an undervalued currency.

New Congress

With a new Congress elected in November, the legislation must pass the House again. The Republican leaders of the panels in charge of trade and currency have other priorities.

Representative Kevin Brady, a Texas Republican who now chairs the House Ways & Means subcommittee on trade, voted against the currency measure last year. David Camp, the Michigan Republican who is chairman of the full committee, said in September that the currency measure was “not on my trade agenda.”

“We’re going to keep pressure on China to float their currency, but we are not going to look at China just through the viewpoint of currency,” Brady said in an interview last month. “We think there are broader issues and a broader relationship with them that we have overlooked.”

Stronger Yuan

The yuan has appreciated more than 3 percent since China ended a two-year peg to the dollar last June. High inflation in China -- prices in November rose 5.1 percent from a year earlier after falling for most of 2009 -- continues to “stealthily” erode China’s competitiveness as U.S. inflation stands at about 1 percent, Paulus said.

China’s exports rose 17.9 percent to $154.2 billion from a year earlier and imports climbed 25.6 percent to $141.1 billion, the customs bureau reported Jan. 10.

Economists including Dariusz Kowalczyk at Credit Agricole CIB in Hong Kong, expect the yuan to gain because of the need to fight inflation and to improve the atmosphere for the Hu-Obama summit that begins Jan. 18.

Li Daokui, an adviser to China’s central bank, said last month that the yuan can strengthen at a faster pace if gains are “controllable.” Twelve-month non-deliverable yuan forwards rose for a fourth day yesterday to 6.4377, reflecting bets the currency will gain more than 2 percent in the coming year.

Stephen Roach

Stephen Roach, non-executive Chairman of Morgan Stanley Asia Ltd., says that while the Obama administration “gets” the effect of price gains on the dollar-yuan exchange rate, the U.S. public and lawmakers may demand more action amid continued high unemployment and a bilateral trade deficit. New commercial deals for companies like Chicago-based Boeing and Redmond, Washington- based Microsoft may not placate Congress, he said.

U.S. and Chinese companies will sign about 40 agreements during the Chicago leg of Hu’s visit, the Chicago Council on Global Affairs said. “We don’t have any details yet on which companies it will be,” said Samantha Skinner, a spokeswoman for the council.

A poll released Jan. 12 by the Washington-based Pew Research Center for the People and the Press, found that 53 percent of 1,503 Americans surveyed from Jan. 5-9 said the U.S. should get tougher on China on the trade and economic fronts.

According to the poll, 47 percent of Americans consider China to be the world’s preeminent economic power, compared to 31 percent who say that title goes to the U.S. The survey had a margin of error of plus or minus three percentage points.

“From the U.S. point of view the domestic political dynamic is more aimed at China,” Roach said in an interview. “This trip is really going to be challenging.”

--Michael Forsythe. With assistance from Mark Drajem in Washington, Flynn McRoberts in Chicago and Li Yanping in Beijing. Editors: Ben Richardson, Peter Hirschberg.

To contact Bloomberg News staff on this story: Michael Forsythe in Beijing at +86-10-6649-7580 or mforsythe@bloomberg.net

To contact the editor responsible for this story: Peter Hirschberg at phirschberg@bloomberg.net

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