Chinese Premier Wen Jiabao's March 13, 2010 statements (discussed in our Update from March 15, 2010, which can be viewed here) that any action to require China to properly value its currency would be as "protectionist," provoked strong reactions from U.S. politicians and officials. The U.S. reactions then gave rise to additional comments from Chinese government officials. The following is a summary and analysis of the current state of play.

Current State of Play

On Monday, March 15, 2010, 130 members of the U.S. House of Representatives, organized by Representatives Mike Michaud (ME-02) and Tim Ryan (OH-17), sent a letter to Commerce Secretary Locke and Treasury Secretary Geitner. The letter urged the Commerce Department to apply the existing countervailing duty (CVD) laws to offset China's undervalued currency. The letter also urged Treasury to cite China as a currency manipulator in its much-anticipated semi-annual report that is due April 15, 2010. The full text of the letter can be found here.

If Treasury were to cite China in its April 15 report, Treasury Secretary Geitner would be required to hold talks with China on the issue, either bilaterally or through the International Monetary Fund (IMF). On March 1, the IMF characterized the yuan as "substantially undervalued."

The issue of China's undervalued currency is not new, but is receiving increasing congressional and media attention. On Tuesday March 16, 14 U.S. Senators, led by Senators Charles Schumer (D-NY), Lindsey Graham (R-SC) and Debbie Stabenow (D-MI), unveiled new legislation intended to addresses situations of currency "misalignment" like that which exists with China's yuan. The Currency Exchange Rate Oversight Act of 2010 seeks to:

  • Establish new criteria to be used by Treasury when identifying "misaligned" currencies;
  • Strengthen existing countervailing duty law to address currency undervaluation;
  • Require new consultations by Treasury with countries identified as having "misaligned" currencies;
  • Implement new penalties and clear procedures for implementing them;
  • Limit the ability of the President to waive penalties for countries that do not act to address their currency misalignment; and
  • Establish a new nine-member body with which Treasury would be required to consult as it develops its semi-annual reports on currency manipulation. The body would be composed of the Chairmen and Ranking Members of the Senate Finance and Banking Committees, as well as the House Ways and Means and Financial Services Committees, with three members selected by the President.

The full text of the Bill, S-3134, can be found here.

Interestingly, Secretary Geitner did not disavow the legislation or the sentiments expressed in the March 15 letter, though he did not give any indication of the Administration's intentions. Indeed, the Administration, Commerce and Treasury have been highly disciplined on this issue, offering only minimal comment.

Following this, on March 21, 2010, Chinese Commerce Minister Chen Denming increased the rhetoric coming from China, claiming that the U.S. government is "obsessed" with China's currency, that the United States would suffer more than China in any trade war, and that if China were cited as a currency manipulator, its government "will find it impossible not to react." Chen also claimed that the U.S. needs to adjust, not China.

Subsequently, in comments made during meetings held in Washington, DC on March 24, 2010, China's Vice Commerce Minister Zhong Shan said that changing exchange rates was not the way to address the enormous trade imbalance between the U.S. and China, and that such a move would upset the global economy. Treasury Secretary Geitner acknowledged that the U.S. could not force China to change its policy of undervaluing the yuan, but said that it is very important that the yuan be allowed to increase in value.

At the same time as Zhong was making his comments, the full House Ways and Means Committee was holding a hearing on China's exchange rate policy. The fact that the hearing was held by the full Committee, and not by the Subcommittee on Trade, indicates the degree of interest and concern in the House of Representatives. The hearing addressed (1) the immediate and long-term impact of China's exchange rate policy on the U.S. and global economic recoveries and, more specifically, on U.S. job creation; and (2) steps that could be taken to address the issue.

Witnesses at the hearing promoted several possible approaches to addressing the issue, including naming China as a currency manipulator in Treasury's April 15 report, seeking multilateral negotiations through the auspices of the G20 or the World Trade Organization (WTO), filing a complaint at the WTO, seeking intervention by the IMF, and acting unilaterally by imposing duties to offset the degree of undervaluation, or by including the issue in countervailing duty investigations. While some differences of opinion exist concerning the correct strategy, there was no disagreement on the need to address this issue.

Analysis

It is no surprise that the rhetoric surrounding this issue is growing in volume, and temperature, as the April 15 deadline for Treasury's report approaches. With the U.S. mid-term elections approaching, and national unemployment around 10 % and much higher in some states (Michigan: 14.9%), pressure on Senators, Representatives and the Obama Administration to address this issue has increased dramatically. The demands for action are increasingly insistent and broad-based. Legislative proposals being made are more refined and credible, and enjoy more widespread support.

There is little debate over the effects of China's deliberate undervaluation of the yuan-its exports to the United States are cheaper, and its exports across the world have a built-in advantage over U.S. products, regardless of the strength of the dollar against other foreign currencies. China's policies are aimed at boosting export-based demand, and by so doing, increasing or at least maintaining employment levels.

From the Obama Administration's perspective, the options have different risks and rewards. On the one hand, by designating China as a currency manipulator, the Administration would formally acknowledge what nearly all policymakers and economists already believe to be true: China is manipulating the value of its currency to help its growth and employment, and it is doing it in a way that deliberately targets the United States economy (as opposed, for example, to accomplishing these goals by stimulating domestic demand). The Administration also would be taking a step that neither President Clinton nor President Bush was willing to take. This would have obvious appeal from a political perspective as the mid-term elections draw near, by demonstrating that the Administration is being willing to be tough on China in order to help the U.S. economic recovery and the prospects for job growth.

Citing China as a currency manipulator, however, would be seen by the Chinese as a direct affront. The Chinese government's sensitivity to anything it perceives to be an attempt to force the country to change its policies likely would unleash a flood of vituperative comments and claims that the United States is engaging in trade protectionism, attempting to deny its own role for its current economy problems by pinning the blame on China, and attempting to inject itself into an area of Chinese sovereignty. Indeed, China's more aggressive posturing on the international stage in recent months could significantly hamper the ability of the Chinese government to offer a response that is anything less than defensive and hostile.

On the other hand, the Administration could again refrain from labeling China as a currency manipulator. This would avoid a direct confrontation between the Chinese and U.S. executive branches, which would theoretically give the Chinese government the opportunity to resume appreciating the yuan without appearing to be caving to U.S. pressure. The Administration, of course, would still retain the ability to change its position in the next semi-annual Treasury report. Whether this more restrained approach would bear fruit, and whether the potential benefits of this approach would outweigh the inevitable criticism the Administration would receive from domestic interests who are clamoring for effective leadership and decisive action on this issue, remains to be seem.

Even if Treasury does not cite China in its April 15 report, the Administration has the additional option of acting immediately to address the issue by having the Commerce Department investigate manipulation of China's currency in ongoing and future countervailing duty investigations. Using the CVD laws in this way enjoys wide support, in both the public and private sectors. In fact, the letter sent to Commerce and Treasury has impressive bipartisan support, being signed by 90 Democrats and 40 Republicans. The likelihood of the Commerce Department investigating China's exchange rate manipulation in countervailing duty cases will increase if Treasury names China in its April 15 report.

Using the existing countervailing duty law to address currency manipulation would allow the Administration to claim that it has acted decisively, and has done so in a way that uses existing law and authority of the Commerce Department, i.e., within existing, accepted institutional structures. There is some difference of opinion on whether using the countervailing duty laws to address currency manipulation is lawful, and any decision by Commerce to impose duties related to manipulated or misaligned currencies would surely be challenged in U.S. courts and before the WTO.

From the legislative branches' perspective, regardless of the Administration's decision on April 15, the prospect of action by the Senate, and likely the House, will remain. In the Senate, the bill recently introduced by Senators Schumer, Stabenow, Graham and others is better crafted than a similar bill introduced by Senators Schumer and Graham in 2009, has a broader base of support and appears to have the potential to advance.

If the Administration declines to act on April 15, pressure on lawmakers to take matters into their own hands will remain and likely increase. The widespread assessment that China's refusal to allow the yuan to find its correct value in the international currency markets confers an improper benefit to its exporters, with the intention of essentially exporting its unemployment to the United States and elsewhere, has a great deal of resonance with lawmakers and their constituents who are facing continuing and serious economic challenges.

Regardless of the decisions made by the Obama Administration in April, China's currency manipulation will remain an important issue with the potential for serious domestic and international consequences. That China is manipulating its currency, and doing so in a way that deliberately targets the United States economy, has become more widely accepted, and the debate now appears to be shifting to how best to address the issue. China's refusal to address the problem on its own is feeding calls for our government to act legislatively on its own. China's increasingly aggressive behavior in the international arena, and particularly its statements on this issue, allow U.S. policymakers and lawmakers to credibly conclude that unilateral action is appropriate. Continued high U.S. unemployment and the coming mid-term elections increase the pressure on elected officials to make something happen before November. This confluence of events contributes to a situation that is as politically and economically delicate and it is important to the future of the U.S. economy, industries and workers.