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Fri Feb 24 11:55:10 PST 2006

Should Americans really want China¹s currency to rise?

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THIS week China¹s Hu Jintao makes the most important trip of his presidency,
his first official visit to Washington. Though much nail-biting has attended
its preparation, this columnist is rather more relaxed about the trip than
are either the Chinese or Americans attending to it, and his reasons are
simple. Mr Hu, for his part, cares only about the style of the visit; he
wishes merely to look like a man of heft and stature on the television
screens back home‹and that is assured: first, because the dear,
stiff-mannered man has thankfully avoided having to chop wood down at
Crawford and, second, because the Americans have no great objection to the
Chinese description of this as a state visit, even if Mr Hu is pointedly not
being offered supper in the White House. George Bush, meanwhile, cares only
about substance, and here, Buttonwood guesses, the president will be able to
wave before the anti-China lobby on Capitol Hill a sheaf of Mr Hu¹s
³assurances² about opening up the country¹s exchange-rate regime, chief
among other things.

The assurances, indeed, have been accumulating since a trip to Beijing late
last month softened the two fiercest China critics in the American Senate,
Charles Schumer, a New York Democrat, and Lindsey Graham, a South Carolina
Republican. The senators had been shrill in berating China for a currency
that they claim is wildly undervalued, undermining American competitors,
destroying American jobs and creating a gaping bilateral trade deficit. They
were the authors of one of the more toxic pieces of legislation to have
floated around Capitol Hill in recent years, proposing tariffs of 27.5% on
Chinese goods coming into America if the Chinese government did not allow
the yuan to move more freely against the dollar. The currency has in essence
been fixed against the dollar for more than a decade, apart from a
less-than-vaulting revaluation of 2.1% last summer, and another climb of
just over 1% earlier this year.

Never mind that the arguments used by the senators to justify their
legislation had only a scant relationship with the world around them. Their
arguments vastly exaggerated the number of American jobs lost to China. They
blamed China for America¹s current-account deficit, of over 6% of GDP, as if
a lack of American saving had little to do with the matter. Meanwhile, they
ignored China¹s benefits to American consumers and, insofar as China is both
a market and a production base, to American companies, too. No, such
unreality has made the conversion of Messrs Schumer and Graham from
attack-dogs to panda-huggers all the more poignant. And it happened in a
classic Beijing way: in a setting of pomp and pageantry, China¹s leaders got
to work on the senators¹ bellies.

The official banquet in the Great Hall of the People, said Mr Schumer, was
better than a Brooklyn takeout. It was indeed ³amazing², a word he was to
use often on the trip: ³It was amazing stuff, not your usual stuff. And they
went easy on us. No sea slugs. No jellyfish.² Mr Graham added that ³it was
the most awesome room.² Professing a new-found empathy for China and the
challenges its leaders faced, the senators postponed a vote on their bill
for six months as soon as they got home. Their hope in China¹s good
intentions on currency reform will have been reinforced by the announcement
late last week, just before Mr Hu set off for America, that the Chinese will
ease their controls on capital. Chinese companies and individuals should
find investments abroad a bit easier to make.

There is nothing wrong with Chinese assurances, so long as you don¹t believe
too pressingly in them. Buttonwood, indeed, has also received a treble-nap
cast-iron assurance from none other than the governor of the People¹s Bank
of China. How, this writer asked the governor, was China going to improve
the levers of monetary and exchange-rate policy? ³Within three years, and
mark my words,² the governor replied, China would have liberalised its
interest rates on deposits and loans, as a step to sound monetary policy and
capital-account convertibility. You can¹t say squarer than that. However,
the assurance was given nearly six years ago, and the governor who gave it
is now happily grazing in other pastures.

The moral of the tale is that disappointment is likely to follow assurance
as sure as a hangover follows maotai. China is not going greatly to revalue
its currency soon, let alone widely liberalise its exchange controls. Though
the economy is galloping along‹apparently by over 10%, year-on-year, in the
first quarter‹the authorities are not going to bring it up sharp at a time
of fragile social stability, dire corporate profitability and investment
bubbles all over the place.

And maybe that is no bad thing. After all, given the creakiness still of
China¹s financial infrastructure and the shocking misallocation by the state
financial system of people¹s savings, what certainty that a liberalised
currency would rise rather than fall in the long run? Freeing the yuan, in
other words, could conceivably mean a stampede into dollars one day.

But suppose that Senators Schumer and Graham get their way, and the yuan
rises as the dollar sinks. Are they really ready for the consequences?
Already, one Chinese bid, by a state oil company for America¹s Unocal, faced
congressional outrage, and was withdrawn last year. But Congress cannot stop
every investment by a Chinese state entity‹just this week talk surfaced of
China Construction Bank taking a 10-20% stake in Bear Stearns, a venerable
Wall Street firm. As Felix Rohatyn, an equally venerable Wall Streeter,
pointed out recently in the International Herald Tribune, these kinds of
deals are probably just the tip of the iceberg. China will soon have $1
trillion in foreign-exchange reserves. While its purchases of Treasury bonds
have helped finance America¹s balance-of-payments deficits, which in turn
has allowed Americans to buy Chinese goodies, China might, Mr Rohatyn
suggests, one day want to invest those dollars with a view to a higher
return‹ie, in American equities. Naturally, a stronger yuan would buy more
shares.

While the broad trend, Mr Rohatyn contends, has been to lift restrictions on
corporate control in America, ³since the 19th century America has not faced
the potential of extensive direct investment under the control of a single
foreign government. That could be forthcoming from China over the next few
years.² It¹s probably not what Mr Schumer and Mr Graham had in mind.

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