U.S. Will Urge China to Boost Interest Rates as Talks Start

Treasury Secretary Timothy F. Geithner will urge China to allow higher interest rates when he meets with Chinese leaders this week, as the U.S. extends its push for a stronger yuan.

Geithner will say China should relax controls on the financial system and give foreign banks and insurers more access, said David Loevinger, the Treasury Department’s senior coordinator for China. Officials from both nations are meeting in Washington today and tomorrow as part of the annual Strategic and Economic Dialogue.

U.S. officials argue that a yuan kept artificially cheap to help exporters also makes it harder for China to lift interest rates and curb an inflation rate that hit a 32-month high in March. China, led at the talks by Vice Premier Wang Qishan, blames record U.S. budget deficits for contributing to lopsided flows of trade and investment.

“It’s pretty clear that the current system is hurting them in their inflation fight,” said Dan Dorrow, head of research at Faros Trading LLC, a currency trading firm in Stamford, Connecticut. “The reason for that is the improperly priced exchange rate.”

The yuan was little changed at 6.4939 per dollar as of the 4:30 p.m. close in Shanghai, according to the China Foreign Exchange Trade System. The currency touched 6.4892 on April 29, the strongest level since 1993.

Domestic Demand

As the talks opened today, Geithner called on China to shift its economy toward domestic demand and said the goals of the two nations are “not in conflict.” Wang acknowledged that there are some “clashes” in U.S.-China economic ties, while also emphasizing the “shared aspirations” between the two countries.

Senators Charles Schumer of New York and Jeff Merkley of Oregon called May 6 for a “rebalancing” in the U.S.-China economic relationship. The two lawmakers, who just returned from a trip to China, said the Chinese need to open their financial sector, address “abnormally low deposit and lending rates” and allow broader market access to foreign firms.

Chinese production and U.S. consumption shouldn’t be such dominating themes, the two Democrats said. “This situation is not sustainable and harms nearly all involved,” they wrote in a letter to Geithner.

China has raised interest rates four times since mid- October and lenders’ reserve requirement seven times. The benchmark one-year lending rate increased 0.25 percentage point to 6.31 percent on April 5. The one-year deposit rate stands at 3.25 percent.

Inflation Eases

The median forecast of 30 economists surveyed by Bloomberg News is for an annual inflation rate in April of 5.2 percent, down from 5.4 percent in March.

Vice Finance Minister Zhu Guangyao said on May 6 that China is paying “close attention” to U.S. efforts to reduce its budget deficit, and his country will focus on improving the quality of its exchange-rate mechanism.

China says a loose monetary policy in the U.S. has helped lower the value of the dollar, stoking global inflation in food and energy. A commentary today by the official Xinhua News Agency said the “plunging” dollar “has become the source of many current global economic problems.”

China held $1.15 trillion in Treasuries at the end of February, more than any other country. The U.S. trade deficit with China came to $18.8 billion in February.

Top Officials

Geithner and Wang will meet alongside Secretary of State Hillary Clinton and State Councilor Dai Bingguo at this week’s meetings, which will draw about 30 top Chinese officials.

The Obama administration and U.S. lawmakers say China’s currency policy gives the nation’s exporters an unfair competitive advantage, costing American jobs. Geithner is trying to convince Chinese officials that a stronger yuan has benefits for their economy.

Geithner said last week that allowing the yuan to rise and making the financial system less dependent on government- controlled interest rates would give Chinese leaders an “enhanced” ability to damp inflation.

The Treasury argues that higher interest rates on deposits will also encourage consumer spending in China, another way to reduce imbalances.

“We’re going to encourage China to move more quickly in lifting the ceiling on interest rates on bank deposits in order to put more money into Chinese consumers’ pockets,” Loevinger said at a briefing last week in Washington.

Limited Gains

Investors are betting the yuan’s rise may be limited over the next 12 months. Twelve-month non-deliverable yuan forwards dropped 0.81 percent last week to 6.3520 per dollar on May 6, their biggest weekly loss of the year, on speculation that China won’t allow faster appreciation to reduce inflation.

John Frisbie, president of the U.S.-China Business Council, said support for a stronger yuan among Chinese leaders has increased in the past year.

“The strong hand has switched over to those who are saying that the exchange rate can help us fight inflation,” Frisbie said in a telephone interview. He said his group, whose members include companies such as Apple Inc. (AAPL), JPMorgan Chase & Co. (JPM) and Coca-Cola Co. (KO), wants China to resume opening its financial services sector to allow more foreign investment.

Foreign Banks

The American Chamber of Commerce in China said last month that foreign banks play an “insignificant role” in China.

Foreign lenders’ market share in China has dropped since the government first opened the industry in December 2006. Banks such as New York-based Citigroup Inc. (C) and London-based HSBC Holdings Plc (HSBA) want to tap household and corporate savings that reached $10 trillion in January as China overtook Japan to become the world’s second-biggest economy.

The U.S. has delayed its semi-annual foreign-exchange report, which had been due on April 15, until after this week’s meetings. The previous report, due on Oct. 15, 2010, was released on Feb. 4 and declined to brand China a currency manipulator while saying the No. 2 U.S. trading partner has made “insufficient” progress on allowing the yuan to rise.

The yuan goes beyond the U.S. and China to become “a multilateral issue, in terms of the impact on Brazil, Korea, Thailand and India,” said Edwin Truman, a former Federal Reserve and Treasury official who is now a senior fellow at the Peterson Institute for International Economics.

‘Causing Trouble’

The “slow” appreciation of the yuan “relative to the dollar in an environment where the dollar is going down against other currencies is causing trouble for other countries and currencies,” Truman said.

Diplomats at the Strategic and Economic Dialogue also will discuss events in the Middle East, including military operations in Libya and the ramifications of the region’s popular uprisings.

Officials are likely to discuss efforts to revive six-party talks on North Korea’s nuclear program. Negotiations between the two Koreas, Russia, Japan, China and the U.S. stalled in December 2008 and tensions flared on the peninsula after North Korea’s Nov. 23 bombing of a South Korean island.

“We want to compare notes on where we stand with respect to North Korea, and we will be very clear on what our expectations are for moving forward,” Kurt Campbell, assistant secretary of state for East Asia, said on May 5.

To contact the reporters on this story: Rebecca Christie in Washington at rchristie4@bloomberg.net; Ian Katz in Washington at ikatz2@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net

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