Thursday, September 23, 2010

Is a Trade War Brewing Between the US and China?

From the FT:

Democratic leaders in the House of Representatives will move ahead with a bill allowing the US to retaliate against China for manipulating its currency, a significant escalation of the dispute between Washington and Beijing.

Sander Levin, chairman of the ways and means committee in the House of Representatives, said on Wednesday the bill would be compatible with World Trade Organisation rules.

But in a largely untested area of trade law the measure will evoke opposition from Beijing and could lead to a legal challenge in the WTO. The bill will go to committee on Friday and could be voted on by the full House as early as next week.


Hours later, Wen Jiabao, the Chinese premier, told business leaders in New York that pressure on Beijing was unwarranted.

“The conditions for a major appreciation of the renminbi do not exist,” he said. If the renminbi were suddenly to rise by a large degree against the dollar, “we cannot imagine how many Chinese factories will go bankrupt, how many Chinese workers will lose their jobs, and how many migrant workers will return to the countryside... China would suffer major social upheaval”.

China unpegged the renminbi on June 19 and allowed it to appreciate after two years of holding it constant but has intervened in the currency markets to slow its rise.

First, let's start with the blatantly obvious: China manipulates the hell out of its currency.

Secondly, the US has not acted on this for reasons unknown. Personally, I think the US is scared to play a game of international relations chicken with the Chinese. However, I can't prove this; that statement is pure conjecture.

Third: China has grown as a direct result of its manipulation. China has developed a pool of investment funds as a result of purchasing currencies on the open market to prevent a run-up in the Yuan's value. As such, they have been able to go around the word and invest in all sorts of infrastructure projects in South America and Africa to develop and extract raw materials to export to China.

Fourth: China does not want to lose its funding source. However, it is probably near the point where the fund -- if prudently managed -- has become self-funding; that is, it is so large that the return on assets is in the multi-millions of dollars on an annual basis. In essence, it operates something like an endowment fund for a large collage or university.

Fifth: while the Chinese have said they would let their currency rise, this is a promise made before major world leader get-togethers to make it look like the Chinese are doing something, only to have the Chinese not act on their promise when the confab is over. In other words, their recent promises to act on the Yuan are public relations with no policy action.

How will this end? I have no idea.