A Travel Alert for John Snow
By David Ethridge
U.S. Treasury Secretary John Snow will soon go to Thailand to meet with finance ministers of the 21-nation Asia Pacific Economic Cooperation organization on Sept. 4-5. At first glance, the trip appears fairly routine, part of APEC's annual gathering. But in the three days leading up to the APEC parley, Snow has a couple of side trips lined up that hold far greater interest to Wall Street and Main Street. He's set to meet with finance officials in Japan and China to discuss a wide range of topics, including hot trade and currency issues.
Snow's trip comes at a particularly sensitive time. In the U.S., a rising trade gap with Asia -- at the perceived expense of U.S. jobs and industrial output -- has the potential to become a political flashpoint in the 2004 election. U.S.-Japan trade frictions are an old story. But China's policies are coming under heavier scrutiny. A bipartisan group of U.S. senators has asked Treasury to investigate if China is unfairly manipulating its currency, the yuan, by keeping its value against the U.S. dollar artificially depressed, thereby boosting exports. Indeed, the Treasury is directed by a provision of the U.S. Omnibus Trade & Competitiveness Act of 1988 to issue an annual review to Congress on international economic and foreign exchange policies of other countries for this very purpose.
Because of the sensitivity of the issue, financial markets should not expect any major announcement from Snow in the wake of his Asia trip, with a strong-dollar policy still the Bush Administration's official stance. Indeed, the U.S. has backed away from a direct call on China to revalue its currency. The Treasury's Undersecretary for International Affairs, John Taylor, suggested as much on Aug. 25, saying China recognizes the need for a more flexible foreign exchange stance, but heavy pressure on the Middle Kingdom to boost the yuan would not be productive.
Given both countries' huge holdings of U.S. Treasury and agency debt at a time of unsettled market sentiment, perhaps the less said on touchy foreign issues, the better. China and Japan together own some $550 billion in U.S. Treasury securities, with the Asian central banks being the largest foreign holders of U.S. debt as a regional bloc. Still, U.S. officials could bring some indirect pressure on China to bend a bit on the yuan next year, while asking Japan to move further along with its structural reforms.
The region's central banks have been significant buyers of agency debt (primarily Fannie Mae and Freddie Mac issues) in the past, with concerns now surrounding housing-related agency debt perhaps leading to less demand going forward. Asian buyers overall held about 25% of Fannie Mae's callable debt, according to an agency spokesperson last month. Moreover, the biggest increase in Asian holdings in recent months has been in non-callable debt, according to Fannie Mae -- Asian investors held 34% of the total outstanding during the first six months of this year.
The downside to getting China and other Asian central banks to allow their currencies to strengthen on their own would be less dollar transactions to be placed in U.S. agency or Treasury bonds. A top Chinese economic official made it clear that the country's foreign-exchange peg to the dollar was good for the global economy and would not be changed anytime soon. There was even an indirect suggestion that further pressure on China to revalue its currency might lead to less official buying of U.S. debt.
No wonder, then, that the Bush Administration is more apt to address the currency and related trade sore spots with a softer tone -- something Snow seems already to have adopted -- and focus on other ways to induce better two-way economic benefits. Also, China is taking some steps outside of foreign exchange to deal with rapid money growth due to inflows from overseas that have resulted, in part, from investors betting on the yuan's upward revaluation. In one step taken to sop up excess funds, its central bank raised the reserve requirement for banks in late August to 7% of deposits, from 6%.
Snow & Co. still have a tricky diplomatic road to traverse, however. Recent gains in the U.S. currency on a trade-weighted basis have led U.S. manufacturing trade groups to complain again about the strong-dollar policy. The Fed's "broad" dollar index has risen some 3.4% from its recent low in June and is down less than 4% from a year ago.
The National Association of Manufacturers has been lobbying the White House over the strong dollar and Asian trade issues, with the textile industry most vocal about the need for tougher action via import controls. And the NAM continued to hammer away at the theme in its annual Labor Day report, released Aug. 27. They claim that unfair international trade practices -- especially on China's part -- and a still-overvalued dollar make it difficult for U.S. manufacturers to raise prices to offset escalating domestic costs like health care, pensions, and new government regulations.
SWELLING TRADE DEFICIT.
While Snow takes the high road, members of Congress could play the bad-cop role with China, especially with the U.S. bilateral trade deficit with China growing $10 billion in June alone and up 25% over last year, to a total of $54 billion so far in 2003. Imports from China hit $12 billion in June, with such numbers suggesting that the trade gap with China will likely top the record $103 billion recorded in 2002.
Meanwhile, with the U.S. economic recovery gaining traction, stronger demand for exports will keep a large trade deficit on politicians' radar screens. So it wouldn't be surprising to see Snow field some tough questions from lawmakers on the strong-dollar policy -- and China's "weak yuan" strategy -- when he returns from his Asian excursion.
Ethridge is a senior market strategist for MMS International