Battling Beijing, With The Gloves Off

China can no longer argue that currency policy is an internal affair

The U.S. and China have for many months engaged in a low-key battle over the relative value of their currencies. But even in the most tense moments the rhetoric has stayed civil -- until now. The Bush Administration took off the gloves on May 17 when Treasury Secretary John W. Snow said "the time has come" for China to drop the rigid currency policies that have helped it to become the world's premier low-cost manufacturing site. Although the U.S. stopped short of branding China a currency manipulator, which would have triggered formal trade consultations, Snow made it clear that Washington wants an end to China's management of its currency and expects some "intermediate" actions by the Chinese soon, laying the groundwork for an eventual floating of the yuan.

RISKY STRATEGY. Such language is sure to raise the temperature of the debate between the two countries. China needs to keep its export machine humming to provide jobs for the hundreds of millions of workers leaving the Chinese countryside. So getting Beijing to revalue the yuan won't be easy, but it's necessary. Maintaining major currencies at artificial levels distorts the marketplace, invites currency speculation, and pits nations against each other on a distorted playing field. The longer the two countries take to resolve their currency battle, the worse for the world economy and financial markets.

To be sure, Snow's tough talk is a risky strategy for the Bush Administration. The Chinese government is notoriously prickly about bowing to outside pressure, especially on actions Beijing views as internal matters. And that's exactly how Premier Wen Jiabao is characterizing China's current deliberations over whether to loosen the yuan's strict peg to the dollar. Wen told a U.S. Chamber of Commerce delegation on May 16 that reform of the yuan's exchange rate "is a matter of China's own sovereignty. Any pressure or media play-up, or politicizing an economic matter, will not help solve problems. China...will never yield to any external pressure."

But the day when China could reasonably argue that its currency policy is a purely internal affair is long past. China, already the world's most populous country, now boasts the world's seventh-largest economy and more than $600 billion in U.S. dollar reserves. And it is a major staging ground for global manufacturing. Indeed, in 2004, China enjoyed a global trade surplus of $32 billion, a figure that could grow up to 40% higher this year. But that number by itself doesn't really show China's full impact on the U.S., with which it had a hefty $124 billion current account surplus last year. China has become America's No. 3 trading partner after Canada and Mexico.

SPEAKING OUT. Much of China's export prowess is due to its low wages, skilled workforce, growing infrastructure -- and the yuan's artificial 8.3-to-1 peg to the U.S. dollar. So although China's rising exports should have increased the value of its currency in recent years, the yuan has actually fallen along with the dollar, giving it a huge export advantage over other foreign producers. That has stoked U.S. fears that China is responsible for the increasing departure of American manufacturing and high-tech jobs offshore. China is right to note that there are other forces wrenching America's economy (a low savings rate, for example). Still, Beijing simply cannot expect the U.S., a country that takes in a third of its exported goods, to stay mum about the effect of lopsided trade.

The Bush Administration, due to recent pressure from both voters and the U.S. Congress, apparently wants to show it is doing something to tame the Chinese trade behemoth. Besides, some Administration insiders believe that two years of relative quiescence on China's currency policy have won Washington little.

Ironically, a Bush Administration success could actually raise costs for two groups: American consumers hooked on cheap import prices and scores of big U.S. companies that depend on China as a cheap manufacturing site. For example, more than 50% of China's exports come from foreign-financed factories, many of them producing for American outfits such as Wal-Mart Stores (WMT ) or Motorola (MOT ). But with the U.S. economy threatening to slow and the Republican Party set to face voters next year, the Bush camp is hard-pressed to avoid a dustup with Beijing.

If a more pointed debate between the superpowers is the only way to bring some clarity to today's global trade situation, so be it. But both the U.S. and China must realize that their growing trade interdependence means they should share a long-term common goal: diffusing protectionist sentiment. Freer trade will allow them both to prosper. Let's hope they recognize that when the dust settles.

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