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Monday, September 22, 2003

China Readies its Excuses

John Snow is about to visit China, and the Chinese are preparing their excuses. Despite all the comparisons with Japan I think it is imporant to understand that the dynamic is going to be very different. Since 1945 the Japanese have never been prepared to confront the US head on. It was only two years ago that Beijing took down a US airplane and refused to back off. Ironically the more pressure the US tries to apply, the more resistance they may encounter. Which doesn't mean that the yuan will not go up. As the spokesmen say, the only firm decision is 'not now'. China will make concessions, but not on fundamentals in my opinion. Essentially I think Andy Xie is right, the most interesting thing for the Chinese to do right now (speaking only about economics) is to fix their financial system. Removing subsidies is only a token gesture, since a 5% increase in costs inside China only translates into a very marginal price change in the US. Really the problem is not that China is exporting too much, it is that the US is exporting too little. That problem can only be solved inside the good ol' US of A (perhaps with a little help from Europe and Japan, who are, after all, the main customers).

China is preparing to reduce incentives for exporters, increase purchases of Treasury bonds and loosen controls on foreign currency holdings to blunt mounting pressure from the United States, where its growing trade surplus has come under heavy political scrutiny, Chinese officials and analysts say. The steps are expected to be among concessions Chinese leaders offer Treasury Secretary John W. Snow on his visit to Beijing this week, although they fall well short of meeting Mr. Snow's demand that China begin allowing market forces to set the value of its currency, the yuan. With Democratic presidential candidates, influential American manufacturers and even Alan Greenspan, chairman of the Federal Reserve, pressing China to overhaul its currency system, officials here are eager to head off trade tensions. But they are also determined to maintain the current exchange rate, set at roughly 8.3 yuan to the dollar, for some time to come. "People do not want Mr. Snow to go away disappointed," said a financial expert affiliated with China's State Planning Commission who has been involved in preparations for the visit. "But the decision on the yuan has been made. There will be no change at this time."

The issue reflects the growing sensitivity of China's trade surplus in the United States and its robust economic growth, which some critics say is coming at the expense of American jobs. It is also an early test for the new generation of China's leaders, who will be called upon to handle inevitable diplomatic frictions as the country attracts tens of billions of dollars annually in foreign investment and posts year-on-year export growth of more than 20 percent, much faster than other major economies.

China passed Japan last year as the country with the largest trade surplus with the United States, at $103 billion. That has made it a prime target for producers of textiles, auto parts and other ailing industries, which say China is stealing their business by currency manipulation. The situation is reminiscent of economic tensions with Japan in the 1980's. China today and Japan then had rapidly growing trade surpluses and currencies that many analysts said were kept artificially cheap to promote exports. On his first stop today in Tokyo, Mr. Snow took veiled aim at both the weak yen and the weak yuan. Yet China's economy now is more open to foreign investment than Japan's was then, and multinational companies like Dell and Wal-Mart influence China's low-cost production as big employers and purchasers. China's leaders know this makes it less likely that they would face heavy trade sanctions, as any penalties would raise the price American consumers pay for goods as diverse as socks and laptop computers, analysts say.

Chinese officials are preparing short-term measures to channel more of the country's export earnings into the international economy without changes in the exchange rate.

One step is to cut or eliminate some export subsidies that give its industries a further competitive edge. Among the possibilities under discussion are steps to cancel or sharply reduce tax rebates paid to exporters in sensitive industries like textiles, shoes and furniture. Mr. Xie (that's MS's Andy Xie, Edward) estimates that a reduction in rebates could force companies in the industries involved to raise their prices by about 5 percent. That could eliminate some of the gain from recent swings in the value of the dollar, although given the enormous cost advantages of producing such goods in China, it would probably do little to stimulate manufacturing in the United States. China is also using its large pool of foreign currency reserves, which now total $356 billion, to buy more United States Treasury bonds. In the first six months of this year, it bought a record $41 billion of Treasuries, less than Japan but far more than any other foreign country.
Source: New York Times

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