NYT: Toughening Its Line, U.S. Warns China About Currency

May 18, 2005 By EDMUND L. ANDREWS

WASHINGTON, May 17 - The Bush administration warned China on Tuesday that its currency policies were distorting world trade, and it brandished the threat of retaliation against the country's exports if Chinese leaders did not change course in the next year.

In language far harsher than it has used before, the Treasury Department declared that China's fixed exchange rate between its currency, the yuan, and the dollar posed a risk to its economy and the economies of much of the rest of the world.

The administration stopped short of accusing China of outright currency manipulation, a move demanded by American manufacturers who complain that the Chinese have artificially undervalued their currency to make exports cheaper in the United States.

But the new language marked a change in relations, which the administration has until now handled with painstaking delicacy.

"Current Chinese policies," the Treasury Department said in a report to Congress on Tuesday, "are highly distortionary and pose a risk to China's economy, its trading partners and global economic growth."

Coming closer than before to setting a deadline, the Treasury report warned that China's policy would meet its definition for currency manipulation unless Beijing officials make a "substantial alteration."

The administration's combative new stance was not enough to satisfy many members of Congress from both parties, who want to soon threaten China with steep tariffs on its exports if it fails to allow the yuan to rise significantly from a narrow band around 8.28 to the dollar.

A stronger yuan would tend to make Chinese goods more expensive in foreign markets, diminishing the country's competitive advantage. Still, economists said even that was unlikely to make a dent quickly in the huge trade imbalance with the United States.

The studied shift in the administration's stance reflected delicate issues that confront American officials, who want China to change its currency practices but are even more worried about pressure from Congress to restrict trade.

In less than a decade, China has emerged as a manufacturing powerhouse and an indispensable source of low-price goods - toys, furniture and electronics, among others. The expiration on Jan. 1 of global textile quotas has flooded world markets with Chinese apparel.

American manufacturers have been caught on both sides of this transformation in trade: often overwhelmed by Chinese competition yet benefiting as buyers of Chinese goods and investors in factories.

Administration officials are also juggling political concerns. As a great power of Asia, China is crucial to Washington's efforts to restrain North Korean nuclear ambitions.

The Chinese Embassy in Washington had no immediate comment. But even before the administration issued its report, Chinese leaders said on Monday that currency policy was a "sovereign" matter and that they would not be pushed into decisions by other governments.

The Treasury warning implicitly gave the Chinese until October, when the administration is required to make its next report to Congress on foreign currency practices. If it declares that a country is manipulating its currency to gain competitive advantage, it is required to begin negotiations over exchange rates that could lead to retaliation.

The United States trade deficit with China reached $124.9 billion last year, larger than that with any other country or with the entire European Union. China has also become one of America's biggest foreign creditors, holding more than $600 billion in Treasury securities and other dollar-denominated instruments as it seeks to keep its currency from rising in line with the trade surpluses.

The Treasury report criticized China's policy as dangerous to itself, its Asian neighbors and global growth. "China's 10-year-long pegged currency may have contributed to stability in the past," said Treasury Secretary John W. Snow, "but that is no longer the case today as China has grown to be a more significant participant in global trade and financial flows."

The policy, he said, threatened the Chinese economy by sowing the seeds of inflation, distorting capital flows and preventing the nation's central bank from conducting normal monetary policy.

Mr. Snow said that China must devise "substantial" changes in its currency practices to make them more "flexible." He did not demand that Beijing move directly to a system of floating exchange rates, like those used by the United States and most of Europe. Most analysts say China is unlikely to do much more than let its currency appreciate by a limited amount, with some estimating an increase as high as 10 percent.

But administration officials said Beijing would have to make changes of "a manner and magnitude that is sufficiently reflective of underlying market conditions."

The direct American language marked at least a partial abandonment of the Bush administration's two-year attempt to cajole China, using "financial diplomacy."

China has pegged the yuan at a fixed rate to the dollar since 1994, when it was beginning to emerge as a force in global trade. Left to free-market forces, specialists say that the value of the yuan would have climbed substantially against the dollar. But China and other Asian nations have kept the value constant by buying hundreds of billions of dollars in Treasury securities.

The Chinese central bank bought more than $250 billion in dollar-denominated securities over the last year and now holds more than $600 billion, according to recent estimates.

The Treasury's report Tuesday did not satisfy critics in Washington.

"The Bush administration is in serious denial with its claim today that China is not manipulating its currency," said Representative Benjamin L. Cardin of Maryland, the ranking Democrat on the House subcommittee on trade.

"In denying currency manipulation by the Chinese, the administration has turned a blind eye to American workers and businesses that are being seriously hurt by China's policies."

The National Association of Manufacturers, which has lobbied for tougher action for two years, said that it was "disappointed" and that Mr. Snow's warning shot was already "long overdue."

But Senator Charles E. Schumer, Democrat of New York and an administration critic, said the tougher language was an improvement.

"They stepped right up to the door, but they didn't knock," Mr. Schumer said. "The good news now is that the federal government - the executive branch and the legislative branch - agree that what the Chinese government is doing is wrong. But we still await action, and that's the only thing that will satisfy Congress."

Mr. Schumer and Senator Lindsey O. Graham, Republican of South Carolina, stunned administration officials last month by winning bipartisan Senate support for a measure that would threaten China with tariffs up to 27.5 percent if it failed to change its currency policies.

The Senate voted 67 to 33 against killing an amendment that would have attached the provision to a spending bill. Mr. Schumer withdrew the amendment, but Senate Republican s have agreed to allow a vote on the measure before the end of July.

Administration officials oppose such penalties for China but also hope the Chinese recognize the risk of provoking political retaliation in Congress if they delay action much longer. "There are very, very strong protectionist sentiments growing in the United States," a senior official said, "and they are directly against China. China could help that situation significantly by moving toward flexible exchange rates."