US tries to tame the Chinese tiger

Congress has become increasingly frustrated by the growing US trade deficit with China.

So far, the Bush administration has employed the arts of persuasion and diplomacy to try to get China to revalue its currency, respect intellectual property rights, and cooperate on energy and other economic issues.

In a sense, those efforts culminate this week. US Treasury Secretary Henry Paulson – with a gang of cabinet secretaries, other leading officials, and Federal Reserve Chairman Ben Bernanke – arrive in Beijing on Thursday for an educational mission.

Their goal: to tell China's top leadership that it is in their nation's best interest to make major concessions on these commercial issues. If they don't do so soon, the trading relationship with their best export customer, the US, will deteriorate.

A stick could replace the carrot.

The takeover of Congress by Democrats next month gives new meaning to such a warning. A host of bills lie in the wings that threaten to damage Chinese exports.

Congress has become increasingly frustrated by the growing US trade deficit with China. US-China trade was an issue in the November elections. Many members of Congress believe China is violating international rules governing trade and finance.

In other words, China is widely seen in the US as a cheater. When President Clinton agreed to China's entry into the World Trade Organization, China promised to let the value of its currency be determined freely by the foreign exchange market, to respect intellectual property rights (i.e., no pirated DVDs), and to establish the rule of law in contractual relationships.

The administration reportedly could charge China today with not living up to its WTO commitments.

"They have moved at a snail's pace," complains Lacy Hunt, chief economist of Hoisington Investment Management Co., in Austin, Texas.

The yuan has appreciated against the dollar by only 5 percent since a July 2005 announcement that China would peg its currency to a basket of currencies, not just the dollar. Many experts say the yuan is still undervalued by 20 to 40 percent.

But China has become such an important economic power that a major yuan shift is now a delicate matter.

"Secretary Paulson is concerned about the weakness in the dollar and doesn't want it to get out of hand," notes Charles McMillion, an economist with MBG Information Services in Washington, D.C.

China has piled up almost $1 trillion in international currency reserves, buying up US dollars on the foreign exchange market to keep the yuan (and thus China's exports) relatively cheap.

Some economists worry that if China, Japan, and other major central-bank holders of dollars were to start dumping a depreciating dollar on the foreign exchange markets, it would force the US to prop up the dollar by raising interest rates and thereby damage its economy.

Mr. Hunt notes, though, that the bulk of official dollar holdings are invested in short-term US Treasury securities. Only 8 percent are in Treasuries with maturities of more than 10 years. Since the Fed can manage short-term interest rates by acting in the money markets (though it can't control long-term rates), the Fed could ease a dollar crisis.

Pressures on the administration to take strong action against China are rising. Some directors of the National Association of Manufacturers met with Mr. Paulson last Monday. "He knows our feeling," says Frank Vargo, a NAM trade expert. "We want to see change."

Similarly, Lloyd Wood, spokesman for the American Manufacturing Trade Action Coalition, warns: "China has to start sounding and acting more reasonably. The mood in Washington is changing." A bill enabling free trade with Vietnam recently failed in Congress. Renewal by Congress of a provision allowing the Doha round of multilateral trade negotiations to continue is unlikely to pass, Mr. Wood says.

Wood's coalition includes many companies hurt by Chinese imports. Since 2001, he adds, nearly 3 million US manufacturing jobs have been lost. Paulson "has to turn up the Bunsen burner" under the Chinese, he says.

Nonetheless, expectations are not high that Paulson will bring back significant Chinese concessions. "We are always hopeful," says Pat Mulloy, a member of the US-China Economic and Security Commission, a bipartisan group set up by Congress. That group views China's refusal to revalue the yuan as a 40 percent price subsidy for its exports.

An undervalued yuan has contributed to the $900 billion US trade deficit, he says. In effect, the US consumes about 7 percent more than it produces in goods and services, piling up foreign debt. Americans are living a lifestyle beyond their means, Mr. Mulloy adds.

Moreover, China is trying to rebuild its ancient high status in the world with its trade and economic policies. Its spending on research and development is now second only to that of the US. It has overtaken Japan on R&D outlays.

Moreover, the US is losing its industrial base, including its military- industrial base, Mulloy charges.

China is even trying to establish its technical standards as those for the world. That's seen in a new third- generation mobile telephone standard China is promoting, says Mr. McMillion.

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