US Criticism Of China to Intensify
With US midterm elections up ahead, we are already seeing political posturing by US politicians regarding China’s currency. Democratic lawmakers are reportedly drawing up legislation that sets criteria on whether a country has a misaligned currency. It would modify the current US Treasury semi-annual report to misalignment instead of manipulation. The House Ways and Means Committee plans a March 24 hearing on the yuan, and so we expect the rhetoric to ratchet up in the coming weeks. It doesn’t help that the US economy is still facing uncertainty, and so politicians are looking for scapegoats. China has not been receptive, with Premier Wen saying this month that countries shouldn’t point fingers and try to force a country to appreciate its currency.
We think a confrontational approach is not helpful, as China has never reacted well to outside pressures or criticism. And it’s not like the US is in a great position to be dispensing economic advice to the largest holder of USTs (we note that benchmark revisions last month allowed China to retake that position from Japan). There is a clear risk that the US pushes this matter too far given the political landscape. If both sides were to take a hardline approach, then the risks would be for a weaker dollar and lower UST prices, as China’s ultimate scorched earth response would clearly be to stop (or threaten to stop) purchases of USTs and dollars. We hope cooler heads will prevail all around. As it is, China’s trade surplus has fallen sharply even as the US deficit has narrowed, so the imbalances are already improving.
Press is reporting that the draft legislation calls for action if Treasury determines misalignment of a currency. The US would be forced to take some sort of action with the IMF and, after 60 days, would have to bar federal procurement from that country. After 360 days of inaction, the US Trade Representative’s office would bring a complaint at the World Trade Organization. We have a hard time believing that the IMF would be drawn into this dispute. UNCTAD is reportedly on the wires today saying criticism of China’s currency policies are unfounded, so this may really be seen as a bilateral dispute. The biggest problem with changing the language to that of misalignment is that currencies are more often misaligned than not. Right now, AUD is about 25% overvalued. Would the US try to punish Australia even though it is not trying to manipulate its currency? Or does it only work only in one direction with regards to undervaluation? And how does one measure misalignment? We note that even the simplest measure PPP is fraught with difficulties, as choice of price index or basket of goods can shift PPP values greatly.
Senior Currency Strategist
Brown Brothers Harriman & Co.
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