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The yuan and the restless
Critics say Chinese currency should trade freely but that could have nasty consequences at home.
May 5, 2005: 12:19 PM EDT
By Chris Isidore, CNN/Money senior writer

NEW YORK (CNN/Money) - U.S. companies, politicians and other critics of the big trade deficit with China say there's one easy way to fix it -- let the Chinese yuan be free.

The critics say a free-floating yuan would rise at least 20 percent in value, making Chinese exports to the United States more costly, ending what some claim is unfair competition by the Chinese.

The U.S. trade deficit with China jumped 30 percent to $162 billion last year, bigger than the gap with Japan and the nations of OPEC, combined, and just slightly less than the nation's total deficit just six years ago.

Last month, finance ministers from the world's leading economies urged China to let the yuan start trading freely. And lawmakers in Congress, worried about the loss of U.S. jobs, are threatening to slap steep tariffs on Chinese goods unless the country changes its currency policy.

But for Americans, letting the yuan rise could have some very unpopular consequences. Interest rates would probably rise, perhaps steeply, along with oil prices -- and even the trade gap with China could be forced up, at least in the short run.

China is believed to be on the verge of a modest revaluation of the yuan, with experts looking for it to rise as much as 5 percent, perhaps soon. But economists say such a small change will do little to lower the deficit with the world's most populous country.

"It gets more and more out of synch every year," said University of Maryland professor Peter Morici. "It'd really be just a fig leaf. In order for there to be a change in the trade relationship, it has to be a large change right off the bat -- at least 20 percent."

If Chinese officials do give in and let the yuan rise, though, it could be a case of be careful what you wish for.

The downside at home

Right now China is one of the biggest buyers of U.S. government bonds, helping keep U.S. interest rates low. But if the yuan rose, the Chinese would probably cut back on their purchases, driving yields on Treasuries and mortgage-backed securities higher.

Ashraf Laidi, chief currency analyst at MG Financial Group, cited estimates that yields on the benchmark 10-year Treasury note are up to 70 basis points below where they would be without purchases by China and other Asian buyers. There are 100 basis points in 1 percent.

If China were to suddenly to drop its yuan-dollar peg, that means long-term bond rates could rise as much as a full percentage point, Laidi estimated.

Just the possibility of a free-floating yuan could drive up long-term rates, said Sung Won Sohn, CEO of Los Angeles-based Korean bank Hanmi Financial. "They don't have to do anything," he said. "If they just say they are going to buy fewer U.S. Treasuries, they can hurt us badly."

Even advocates of a free-floating yuan agree it will mean higher rates in the United States.

"Mortgage rates are going to go up, the long bond rate is going to go up," said Maryland's Morici, who has long been calling for China to let the yuan rise. "The only question is what is the precipitating event."

Meanwhile, a rising yuan would let China, already a big oil importer, buy even more oil for the same number of yuan, since oil is priced in dollars worldwide -- a move that would put upward pressure on oil prices.

"It is a country interested in growing rapidly, and one of the big bottlenecks in its growth has been energy," said oil analyst Peter Beutel, president of Cameron Hanover. "If it was suddenly trying to buy 1.5 million barrels today, it'd sop up most of the surplus right now."

The job question

Some critics say China's undervalued yuan costs American jobs by making it tougher for U.S. factories to compete.

"Until they start playing by the rules, our manufacturing industry will continue to bleed jobs because of unfair Chinese trade practices," said Sen. Lindsey Graham, a South Carolina Republican pushing a law that would slap 27.5 percent tariffs on Chinese exports if Beijing doesn't revalue the yuan.

But many economists say China would still have a significant cost advantage over U.S. factories, even with a stronger yuan. Many of its government-directed companies could afford lower profits or even losses so as not to lose U.S. sales.

And even a rising yuan probably wouldn't bring jobs back to the United States.

"In my opinion (low-cost production) would shift to elsewhere in Asia, perhaps to Africa," said Joanne Thornton, international trade analyst for Stanford Washington Research Group. "It's hard for me to imagine a situation where ... production that moved overseas would shift back to the United States."

Maryland's Morici said at best a rising yuan might stem further losses of U.S. jobs to competitors overseas. But some higher-end U.S. plants would become competitive with Chinese counterparts again, he added.

And while a stronger yuan is meant to close the U.S.-China trade gap, the immediate impact would probably be the opposite. Some Chinese exports would fetch more dollars while U.S. exports to China, worth $3.3 billion last year, would be worth less.

Change expected to be slow

No one knows exactly what a freely traded yuan would be worth. Morici and others say it should trade at around 5 yuan to a dollar, rather than the current fixed rate of about 8.3. Others say years of pent-up imbalance could result in an even bigger shift.

But even with all the talk of a revalued yuan, few experts expect any change soon.

Laidi at MG Financial Group said there could be a move to a more freely traded yuan by the time the Olympics come to Beijing in 2008. Others think it could be years later.

"I think the Chinese strategy is give as little as possible and take as long as they can" to a free-floating currency, said Hanmi's Sohn.

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