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Senators Urge Cheney To Make Chinese Currency Manipulation Top Issue At Davos

With Yuan destabilizing world economy, bipartisan group of Senators ask Cheney to use World Economic Forum to pressure on China to float currency

US goods having hard time being sold in Europe because of undervaluation of yuan

A bipartisan group of Senators today urged Vice President Cheney to make China's currency policies a top priority at the World Economic Forum in Davos, Switzerland. The Senators said that China's manipulation of the yuan has become a destabilizing force in the world economy and has led to major international exchange rate and trade imbalances throughout the world.

In a letter being sent to Cheney today, Senators Charles Schumer, Jim Bunning, Dick Durbin, Lindsey Graham, Evan Bayh and Christopher Dodd asked the Vice President to discuss the impact of China's currency manipulations at the World Economic Forum in an effort to build international pressure on the Chinese Government to float its currency. Cheney is leading the US delegation to the Davos forum.

"We believe China's currency policies and the deep undervaluation of its currency, the yuan or renminbi, have not only contributed to job loss and business failure in the United States, but they are also leading to major international exchange rate and trade imbalances and have become a destabilizing force in the global economy. In your capacity as the leader of the US delegation, we respectfully urge you to make this issue a top priority at the World Economic Forum in Davos, Switzerland," the Senators wrote in their letter.

The yuan has been pegged to the US dollar since 1994. Given China's enormous growth over that time, many economists believe the yuan may be undervalued by 15% to 40%. The practical impact of China intentionally lowering its currency's value is to make its goods and services cheap internationally. This means that when Chinese manufacturers export a product, they effectively receive a 15% to 40% subsidy on their exports, providing them with a nearly insurmountable advantage over US producers.

In their letter to Cheney, the Senators wrote that China's currency manipulation is exacerbating the US trade deficit with China which now stands at $126 billion. The macroeconomic effect of the trade deficit with China should be a decline in the value of the dollar and an increase in the value of the yuan. Over time, this would serve to "self-correct" the trade deficit: US goods would become cheaper and Chinese goods would become more expensive. But since China's currency is pegged to the dollar, the yuan's value goes up or down with the dollar and no self-correction takes place.

Since China and the US sell their goods in many of the same international markets, US goods do not gain the export advantage they should get when the dollar falls – As US prices fall, so do the prices of the Chinese goods they are competing against. In addition, the Chinese government's intervention in the value of the yuan has led it to purchase dollar denominated assets in massive volumes, creating sovereign demand for the dollar that does not reflect true market demand. This prevents an orderly decline in the dollar's value and, as pressure builds, puts the dollar at risk of a precipitous fall.

In Europe, China's artificial peg to the dollar has led the Euro to bear the brunt of the dollar's fall. With concern rising about the dollar's value due to the United States' twin trade and budget deficits, currency traders have only one major currency on which to place their bets. Since China's currency value is artificially fixed (and Japan's currency is effectively fixed through massive government intervention), only the Euro provides traders with an opportunity to ride a major currency up as the dollar declines. The result has been a more than 20 percent appreciation in the Euro's value against the dollar over the past year.

"As the yuan rides the dollar down, Chinese goods are becoming even more competitive in the European markets. This hurts European manufacturers and other major exporters and puts Europe's fragile economic recovery at risk. As the United States' second largest export market, a weakened Europe threatens our own economic recovery," the Senators wrote.

As China has become more internationally competitive, firms that were investing in developing nations have shifted capital and operations to China. In 2002, foreign direct investment (FDI) in China was $53 billion, making it the world's largest destination for FDI while FDI in developing countries fell by more than 25% according to the United Nations.

Finally, China's undervalued currency is a risk to its own economy. The expansion of China's money supply, exacerbated by its undervalued currency, is a large factor behind the easy credit and problem loans now plaguing China's financial sector. The Chinese government no doubt believes it can successfully manage the inflationary pressure now building in its economy, but there is evidence that China's economy is overheating and creating a dangerous speculative bubble. As Morgan Stanley's chief global strategist, Barton Biggs, has pointed out, "A country that does not have a free market capital allocation mechanism is uniquely unqualified to mitigate the excesses of an investment boom."

"Despite many months of concern from members of Congress, as well as efforts by the Administration, the Chinese government has made no changes to its currency policies. The yuan remains fixed at the same rate it has been for over ten years. There have been many statements of good intentions, but no real progress. We have already seen China contribute to one currency crisis when in 1994 it devalued its currency by more than 30 percent causing the major dislocations in the trading flows of east Asia which precipitated the Asian currency crisis... Mr. Vice President, if China enjoys the benefits of membership in the international economic community, as it clearly has, we hope you agree that it is only fair that it abide by the community's rules and responsibilities. The time for change is now, before the global economy is put further at risk."

Schumer is sponsoring bipartisan legislation (S. 1586) that would apply a "symmetrical" tariff of 27.5% across the board to products from China in line with China's currency undervaluation. It would allow the President to remove sanctions once he certifies that China has moved to a market-based currency. The tariffs would kick in after a grace period of 180 days to ensure that Treasury officials have adequate time to work with the Chinese government to institute reforms.

For a copy of the letter click here.


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