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China: the “New Japan” of Trade Policy?

By Russell L. Smith and Caroline G. Cooper, Willkie Farr & Gallagher, LLP

In the 1980s and 90s, Japan was the scapegoat that was blamed for plant closings and job losses in the U.S. manufacturing industry. These days, that label is more and more being conferred on China. In the past few months, many U.S. manufacturing sectors have united around the claim that their high production costs render them unable to compete with low-priced Chinese imports. They assert that their problems would be solved if the Bush Administration and Congress take immediate steps to force China to allow the yuan to float, or to impose tariffs that will offset China’s claimed exchange rate advantage.

So far, the Administration has reacted to these industry pressure tactics by encouraging China to free float the yuan, but not insisting on immediate action. Officials, at least those from the Treasury Department, recognize it will take time for China to adopt a market-based exchange rate so as not to precipitate an implosion of what is, for its massive bulk, a quite fragile Chinese economy. In a move more directly responsive to industry and Congressional pressure, the Administration has also encouraged major trading partners, especially those in Asia, to support flexible exchange rates. At the recent G-7 Finance Ministers meeting, Treasury Secretary Snow successfully convinced Ministers to include in the final communiqué a mild statement that endorsed more exchange rate market flexibility. Even this rather reserved action has caused temporary turmoil in exchange markets, driving up the value of the yen quite significantly.

Members of Congress are significantly less sophisticated in their approach to this issue, and are acting mainly in response to 2004 election prospects, which are expected to be strongly influenced by employment levels. In the past month, a number of resolutions were introduced in Congress demanding action on China’s alleged currency manipulation, and one urging (but not requiring) new initiatives by the President has passed the Senate. While more aggressive legislation may never be enacted into law, the message to policymakers and U.S. trading partners is clear--continuing exchange rate problems are heightening trade tensions and therefore the prospects for imposing trade remedies.

Addressing the China Problem: China’s alleged currency manipulation became a priority issue for Congress last May as a result of a hearing convened by House Commerce-Justice-State Appropriations Subcommittee Chairman Frank Wolf (R-VA). Agricultural producers joined furniture and pharmaceutical manufacturers in testifying that the Chinese government supported a monetary policy that kept the yuan pegged at an artificially low exchange rate relative to the dollar. They considered China’s undervalued currency to be a subsidy, warranting action under U.S. trade remedy law.

The issue continues to warrant attention because legislators claim they can quantify the extent to which China can manipulate the yuan and the impact this has on the U.S. economy. Legislators say that China can intervene in the exchange rate market at any time because it has large foreign exchange reserve holdings. They also claim that China’s currency manipulation has given rise to a soaring U.S. merchandise trade deficit. The latest Census Bureau data shows the U.S. merchandise trade deficit with China through the first seven months of 2003 comprised nearly 21% of the overall U.S. merchandise trade deficit. U.S. imports from China in July 2003 reached a record monthly high of $13.4 billion, with no diminution in sight as the year-end holiday selling season approaches.

At a September 9th Senate Foreign Relations Committee hearing on U.S.–China relations, Republican and Democratic Senators charged that actions by the Chinese government to manipulate the yuan violated WTO rules. They expressed concern about statements by Treasury Secretary Snow following his trip to China that the Administration would do little in the near future to pressure China to float the yuan. Administration witnesses offered assurances that the United States would ensure that China complies fully with all of its WTO commitments. They cautioned, however, against thinking that the “structural problems” in the Chinese economy that are driving China’s leaders to control the value of the yuan could be resolved overnight. These include billions of dollars in doubtful loans, problems with state-owned industries, high unemployment, and potential instabilities resulting from burgeoning foreign investment flows.

It is also noteworthy that some major U.S. industrial sectors, particularly the U.S. auto industry, do not support these initiatives. They have substantial investments in China, which would be adversely affected by a stronger yuan. While they have not publicly opposed the business community’s efforts regarding China, when asked they argue that for them, Japan’s intervention in currency markets is more detrimental that China’s refusal to float the yuan.

This caution seems to have had little impact either on the affected U.S. industries or the Members of Congress who support them. Since September there has been a continuing flow of legislative proposals threatening trade restrictions against China, and justifying such threats by asserting that currency manipulation violates U.S. trade remedy laws and WTO subsidy rules. S. 1586, introduced on September 5 by Senators Schumer (D-NY), Bunning (R-KY), Dole (R-NC), Durbin (D-IL), and Graham (R-SC) authorizes the Treasury Department to enter into negotiations with China to float the yuan and to certify to Congress that the Chinese government is no longer intervening in the exchange rate market. If the Chinese government fails to value base the yuan on an acceptable market rate within a specified period of time, the Administration would be authorized to impose an across-the-board tariff on all Chinese exports to the United States of 27.5%--an amount equal to the claimed average percentage rate by which China has devalued its currency.

The House companion bill, H.R. 3058, would also require the Treasury Secretary to report annually to Congress on how China has manipulated its currency. The legislation authorizes the Administration to impose a tariff, and in some cases an additional tariff, on all imports from China at a percentage rate “equal to the rate of manipulation.” Although these bills will most likely never become law, the extreme approach they take invite use of existing trade remedy laws, such as dumping and safeguards. These appear moderate by comparison although in reality are just as exclusionary.

The proposals that have received favorable attention on Capitol Hill and in the White House are those that are WTO-consistent and encourage, rather than threaten, affected countries. Some of these bills broaden the countries of concern by including Korea, Japan, and Taiwan, as well as China as alleged currency manipulators. Some also include potential calls for “unfair trade practice” actions under Section 301 of the Trade Act of 1974. This long-dormant provision permits the United States to investigate and negotiate with other countries on unfair trade practices, but any action to restrict trade could only come as a result of a successful WTO dispute resolution case. That, in turn, is highly unlikely, since it is unclear whether the WTO rules would permit such a case, whether exchange rates are a valid basis alleging WTO inconsistency, and whether the Administration would be willing to bring such a case.

Next Steps: Given the current “jobless recovery” in the United States, these trade-related political pressures are no surprise. The next step for legislators and manufacturers is getting the Administration to do more to press China to float the yuan. For now, President Bush wants limited pressure on China. The most that legislators can probably expect from the Administration in coming months is that the annual Treasury Department report to Congress on foreign exchange rates will include a lengthy section on China. If the White House decides to put more pressure on China, it is difficult to know how that will manifest itself. It is entirely possible, if not probable, that future cases seeking special safeguards against Chinese imports will be more successful than those brought in the past. This would be the type of “signal” that the Bush Administration could be expected to send to China. This would express that China is free to act as and when it wishes on exchange rates, but that as long as the perceived currency manipulation persists, the Administration will respond to political pressures with the tools over which it has discretion. These include trade remedy laws, which allow affected U.S. industries to protect themselves, at least temporarily, from Chinese imports.


Editor: Dr. Scott B. MacDonald, Sr. Consultant

Deputy Editors: Dr. Jonathan Lemco, Director and Sr. Consultant and Robert Windorf, Senior Consultant

Associate Editor: Darin Feldman

Publisher: Keith W. Rabin, President

Web Design: Michael Feldman, Sr. Consultant

Contributing Writers to this Edition: Scott B. MacDonald, Jane Hughes, Marc Faber, Jonathan Lemco, Russell Smith, Andrew Thorson and Robert Windorf



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