FX COLUMN-China, U.S. back on collision course over yuan

August 13, 2010

— Jeremy Boulton is an FX market analyst for Reuters. The opinions expressed are his own —

By Jeremy Boulton

LONDON, Aug 13 (Reuters) – The United States and China are again on collision course over the yuan, bringing the threat of protectionism and the potential to tip the world back into recession.

An export led recovery, or at least a recovery aided by a more competitive export sector, has been seen as an easier option than boosting demand for governments trying to shore up their economies.

This has led to officials talking down currencies or actual FX interventions, the latter being the preferred policy for many Asian central banks.

U.S President Barack Obama has played the export card with his pledge to double exports in five years. China, on the other hand, has supposedly played ball, allowing the yuan to appreciate.

The reality though is very different.

Earlier this week U.S politicians gnashed their teeth after China’s trade surplus blew out to an 18-month high in July. Senator Charles Schumer is pushing hard for U.S legislation to put an end to what he sees as unfair China trade practices.

A shock widening of the U.S trade deficit followed on Wednesday, boosted by a huge rise in Chinese imports. The alarm bells in the Senate will be ringing ever louder.

It was notable that U.S exports actually dropped 1.3 percent month on month in July after the authorities had made such a big deal about promoting the sector.

But those watching the unwelcome return of the trend of widening deficits in the United States will definitely see the dollar’s rise this year as a source of increasing concern.

China provided the coup de grace on Thursday, fixing the yuan at a seven-week low against the dollar. This is certain to be seen as an unreasonable action in the United States.

USD/CNY was fixed at 6.8015, meaning the yuan had gained around 0.3 percent versus the dollar in nearly two months. Even worse the fix represented the biggest one-day move in dollar/yuan since the June 19 de-pegging.

China authorities thus appear far more likely to respond to dollar strength or apt to hold dollar/yuan steady, or boost the rate if a weaker euro puts pressure on the yuan basket.

None of that will wash in D.C. Rather, the yuan de-pegging is widely seen, as many feared, as a purely political gesture designed to throw U.S bloodhounds off the scent.

Calls in Washington to label China as an FX manipulator will be back on the table. The danger is that such action brings with it the prospect of a trade war as duties are levied.

Speculation often follows that China might reduce or stop buying U.S. assets in response to U.S. protectionist measures. Quite what China would buy instead is rarely discussed.

What counts today in respect of the yuan story is the more risk averse state of financial markets, which leaves risk takers more apt to respond to any escalation hostilities. That these are confined to words, not action, is of limited comfort.

The next Treasury semi-annual currency report (originally scheduled for October) will be closely watched. Treasury Secretary Timothy Geithner said that what counts is how far and how fast the yuan appreciates.

This time around it hard to envisage U.S. senators being calmed by words. This time they may demand action. Introducing protectionist measures during an initial and gradual recovery phase has an ominous feel.

It will have the doomsayers reflecting on the 1930s, but whilst that is too pessimistic for many, the worst-case scenario is certainly sufficient to tilt the global economy back into recession. ((jeremy.bolton@thomsonreuters.com, +44 20 7542 8780, Reuters Messaging: jeremy.boulton.reuters.com@reuters.net, editing by Nigel Stephenson))

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