NYT : Bush's Choice - Anger China or Congress Over Currency

May 17, 2005 By EDMUND L. ANDREWS

WASHINGTON, May 16 - After two years of prodding China to relax its fixed exchange rate to the dollar, the Bush administration faces a choice of incurring the wrath of China or of Congress.

On Tuesday, the administration will offer its latest verdict on China's foreign exchange policies. It will either anger China by accusing it of manipulating its exchange rate to gain an unfair trade advantage over the United States, or it will anger Congress by giving China a clean bill of health.

The report to Congress, already one month late, will come as many Republicans and Democrats are clamoring for restrictions on Chinese imports as well as expressing skepticism about trade-opening deals in general.

Treasury Secretary John W. Snow is under intense pressure to declare that China has been deliberately undervaluing its currency, the yuan, to keep Chinese exports cheap and build its huge trade surplus with the United States.

Mr. Snow has repeatedly refused to make such an accusation, arguing that the United States should simply use "financial diplomacy" to persuade China that flexible exchange rates would be in its own interest.

If the Bush administration changes course, it would be required by law to open "consultations" with Chinese leaders and then to take some kind of action if China refused to change its policy.

If the Bush administration points the finger at China, it may simply harden Chinese opposition.

But if it gives China another clean bill of health, Congress will be more likely to pass legislation demanding tougher restrictions on Chinese imports.

Last month, the Republican-controlled Senate voted 67 to 33 for a measure sponsored by Senator Charles E. Schumer, Democrat of New York, and Senator Lindsey O. Graham, Republican of South Carolina, that would impose a 27.5 percent tariff on Chinese imports if China failed to change its currency policies.

After hurried negotiations, Mr. Schumer and Mr. Graham agreed to withdraw their amendment after the Senate Republican leader, Bill Frist, agreed to give them a vote on the bill in July.

On Monday, aides to Mr. Schumer said he would redouble his efforts if Mr. Snow again refused to accuse China of currency manipulation.

In addition to pushing for his previous bill, Mr. Schumer plans to introduce another bill that strictly defines "manipulation" and would force the administration's hand.

Experts are sharply divided about the wisdom of pushing harder. C. Fred Bergsten, director of the Institute for International Economics, has long argued that the United States ought to accuse China and take its case to the International Monetary Fund.

Others, including some frequent critics of administration policy, say belligerence would be misplaced.

"The harder the U.S. hectors the Chinese government, the less inclined they will be to move," said Barry Eichengreen, a professor of economics at the University of California, Berkeley. "Ratcheting up the pressure now is counterproductive."

If China were to relax its 10-year-old policy of pegging the yuan to the dollar, the action might have only a limited impact on the United States trade deficit but a significant impact on inflation and interest rates.

To keep the yuan at an unchanged value relative to the dollar, despite China's ballooning trade surplus with the United States, Beijing has been a huge buyer of United States Treasuries and other securities.

Last year, the Chinese government bought more than $200 billion in Treasuries, and its total foreign reserves ballooned to $650 billion.

Those purchases, combined with similar efforts by other Asian central banks, financed more than two-thirds of the United States' record trade deficit last year of $617 billion.

If China and other Asian countries were to slow their purchases of Treasuries, long-term interest rates in the United States could increase at the same time that the Federal Reserve is pushing up short-term rates.

Nouriel Roubini, an economist at New York University, has warned that the United States could pay dearly in higher interest rates if China did let its currency float freely.

Federal Reserve officials have estimated that Asian central banks' impact on American interest rates is modest - keeping them about half a percentage point below what they might otherwise be.

Long-term rates have remained at low levels, hovering about 4.2 percent on 10-year Treasury bonds, even though inflation has picked up over the last year and the Fed has been raising short-term interest rates.

But many analysts say interest rates are low around the world, in part, because investment is sluggish in Europe, Japan and many Asian nations outside of China.

"China by itself is a relatively small part of the puzzle," said Desmond Lachman, an economist at the American Enterprise Institute. "I don't think Treasury rates go up very much at all, even if China lets its exchange rates float freely."

Some analysts predict that China's first step toward flexible currency rates could force it buy even more Treasury bonds. Many analysts predict China will raise the yuan's value against the dollar by 5 or 10 percent, a move that will simply encourage investors to bet even more heavily on further revaluations.

Speculators are already pouring money into China, circumventing official restrictions to the extent possible, as they bet on a rise in the yuan's value. If those purchases accelerate, the Chinese government will have to buy additional Treasuries to keep its currency from rising even further.

The Bush administration has stepped up pressure on China. Last month, Mr. Snow and other top officials declared that China had made enough preparations for a flexible currency and was "now ready."

Rob Portman, the United States trade representative, has promised a review of complaints about Chinese trade practices, including complaints by American companies about widespread violations of American copyrights and patents.

Last Friday, the Commerce Department announced plans to reimpose import quotas on Chinese-made shirts, trousers and underwear, prompting angry protests from Chinese leaders.

But Chinese leaders insist they will not be pushed into change, particularly when it comes to the value of the yuan, or renminbi.

"The renminbi's foreign exchange rate reform is the sovereign issue of China," said Wen Jiabao, China's prime minister, according to remarks published on Monday by the Xinhua News Agency. "We respect the order of the market economy, but we do not succumb to outside pressure."

Mr. Snow, in an interview on Monday with CNBC, reiterated his optimism that China would change policy on its own.

"I'm convinced they will move," Mr. Snow said. "Now is the time. We're anxious to see them move. It's time."