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    China Business
     Jul 28, 2007
Additional US pressure on the yuan
By Zhou Jiangong

SHANGHAI - From the Tiger Leaping Gorge in remote, mountainous southwestern China to Qinghai Lake on the sublime Tibet-Qinghai Plateau, Henry Paulson, the US treasury secretary, always shows his passion on China's environmental protection.

But on top of the agenda of his weekend trip to China is still the yuan issue. The visit follows up the second round of the Strategic Economic Dialogue in May, which did not make any breakthrough

on China's currency issues.

"This trip is part of an ongoing process to strengthen our strategic economic relationship - to address long-term issues such as working with China to rebalance its growth and increase the flexibility of its currency," said Paulson.

The trip is just days after the second anniversary of China's so-called exchange-rate reform. On July 21, 2005, China de-pegged the yuan, its currency, from the US dollar and allowed it to appreciate against the greenback by 2.1%. Since then, the yuan has been on a path of slow appreciation and is going up a bit faster this year.

The timing is also subtle. US politicians are increasingly impatient with the alleged "undervalued yuan" that they think gives Chinese companies an unfair trade advantage over the United States.

Just before Paulson left for China, the US Senate Finance Committee voted 20-1 on Thursday to give the US government new tools to press China on the yuan revaluation, although the administration of President George W Bush said it opposed the bill. The overwhelming vote shows Congress is headed toward passing legislation by a big enough margin to overcome any presidential veto, said Senator Charles Schumer, a Democrat who helped craft the measure.

The sponsors of the bill presented to Congress in May are confident that it will pass with a veto-proof margin. Specifically, it would require the treasury secretary, in consultation with the Federal Reserve Board chairman, to issue twice-yearly reports that review, evaluate and analyze currency markets, currency-intervention policies of the United States' major trading partners, identify and determine so-called fundamentally misaligned currencies, and develop a priority list for actions.

The bill's most significant provision requires the Commerce Department to take "currency undervaluation" into account when calculating anti-dumping duties on foreign goods, said Senate Finance Committee chairman Max Baucus, a Democrat. That could lead to higher duties already in place on many Chinese products, and encourage US companies to seek new duties on additional Chinese goods.

A Department of the Treasury statement said that Paulson would "raise with Chinese leadership issues of concern to the US Congress in his meetings there". The leaders include President Hu Jintao and Vice Premier Wu Yi.

More international economists have been persuading Chinese government to allow yuan to appreciate faster. More mainstream economists in Beijing believe that yuan appreciation will be a necessary step to address spiking structural issues embedded in China's economy and largely in China's own interests, instead of the United States'.

In fact, the appreciation of the yuan has been accelerating. Its appreciation in the second year after the de-peg is at a rate tripling that in the first year. The market expects that the yuan will gain 5% in 2007, meaning that a US dollar would be valued at 7.4 yuan by end of the year.

Employment of millions of workers in export-oriented factories in coastal provinces is the major concern of the Chinese government on yuan appreciation. But the two-year appreciation has shown that China's export juggernaut has not lost its steam and is becoming even more robust.

According to a survey by China Business News, a leading business newspaper based in Shanghai, nearly half of export-oriented companies in the Pearl River Delta and the Yangtze River Delta, China's two most dynamic export bases, said the yuan's appreciation does not have any impact on their employment plans, and more than a quarter of companies said they might cut the number of workers by less than 5%, and some factories are even considering an employment increase.

In January-June 2007, China's trade surplus was US$112.47 million, two-thirds of the surplus in all of 2006. The sustained ballooning trade surplus assured the government that a bit faster appreciation does not hurt China's export momentum.

In the short term, beyond the knowledge of Capitol Hill politicians, yuan appreciation may be responsible for the fast growth of China's trade surplus. Yuan appreciation instantaneously makes China's export goods more expensive in dollar terms, but increments of appreciation may not have any impact on the volume of exporting at all.

To contain the ever-growing exports, the Chinese government, which is more confident handling the pace of appreciation, needs either to accelerate the appreciation or use other policy tools for more balanced trade, or both. However, analysts say that while Beijing may allow greater flexibility of the yuan, it will resist letting the yuan float freely. In other words, Beijing still sticks to a gradualist approach, though this time it is a more aggressive one.

This is what the government is doing. For the second time in 12 months, China reduced or scrapped altogether tax rebates to 2,381 export good items. The government on Monday announced a new policy that seeks to curb the development of the processing trade in labor-intensive industries covering 1,853 products in plastics, furniture and textiles and other industries. The policy will take effect on August 23.

Paulson said he will also address short-term issues "as they arise".

Consumer-goods safety could be one of the short-term issues. In recent months, the US Food and Drug Administration has tightened its checks on goods imported from China, and US media have been bashing "made in China", from pet food, toothpaste and seafood to tires. Acknowledging the goods-safety issues and strengthening the crackdown on inferior producers, China is criticizing the US media for "demonizing" China's goods. As a retaliatory measure, China is tightening its checks on goods from the US.

Climate change could be one of the dominant issues in the fourth round of economic talks to be held in Beijing in December. "The only way to make progress on climate change is to engage all the large economies, developed and developing, to work toward embracing cleaner technology and reducing emissions," Paulson said.

The Bush administration, reluctant to be a leader in reducing emissions and recognizing that China one of the biggest emitters of pollutants, is intent on using the economic-dialogue forum to bring China on board to deal with harmful emissions by shouldering more responsibilities.

Zhou Jiangong is a Shanghai-based analyst on China's economic, political and foreign affairs.

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