Putting Pressure On China's Peg

U.S. Wants Change in Currency Policy, but Benefits Aren't Clear-Cut

William Zeus's anger is palpable as he recounts how cheap Chinese imports have forced his company, National Tool and Manufacturing Co., to close two plants and lay off abou t 55 workers in the past couple of years. The problem, according to Zeus, is that China enjoys an unfair advantage in world markets: the artificially low exchange rate of its currency, the yuan.

"There's not a lot to it except arithmetic," said Zeus, whose Kenilworth, N.J., firm makes sophisticated tools and components for makers of molds used in manufacturing. "In our industry the Chinese are often 30 percent, and sometimes 50 percent, cheaper than products made in the United States. A lot of that has to do with the fact that the yuan is undervalued, which means that goods imported from China are cheap."

A clamor of similar complaints from America's industrial heartland is galvanizing official Washington into action. Whether such action will benefit manufacturers like Zeus, however, is a matter of considerable debate.

At issue is China's policy, which it has maintained since 1995, of keeping the yuan pegged at 8.28 yuan per dollar. That value for the yuan, Beijing's critics assert, is substantially lower -- by 15 to 25 percent, or perhaps more -- than the rate that would prevail if China allowed the yuan to rise and fall with supply and demand as most other major currencies do. The result, they say, is a sharpening of China's competitive edge that has been a major factor behind the explosive rise in the U.S. trade deficit. China accounted for one-quarter of the record $651.73 billion trade gap in goods in 2004, and in the first two months of this year, the U.S. deficit with Beijing surged to $29 billion, up about 50 percent from the same period a year earlier.

Members of Congress from both parties have responded by introducing legislation that would slap across-the-board duties on Chinese imports unless Beijing lets the yuan move significantly. Despite objections that such duties would violate international trade rules, the bill drew support from 67 senators on a procedural vote last month, surprising even its backers.

"We kept hearing from one business after another that the problem we have with China is all-encompassing, but one major problem is the value of their currency," said Sen. Lindsey O. Graham (R-S.C.), who sponsored the bill with Sen. Charles E. Schumer (D-N.Y.).

Thanks in part to the groundswell on Capitol Hill, the Bush administration is also stepping up pressure on China. Until recently, the administration was taking a patient stance in the hopes that China would act on its own. But in the past couple of weeks, top U.S. officials have adopted a tougher tone. A fresh statement of the administration's new line came last week at the Asian Development Bank's annual meeting, where Bobby J. Pittman, the chief U.S. representative, declared that China "should move to a more flexible regime now."

Moreover, the Treasury Department is planning to release a report soon on the foreign exchange policies of other nations, which is almost certain to take a more critical position toward China's practices than past years' reports. Manufacturing industry groups are urging the Treasury to formally brand China a "manipulator" of its currency, which would require the department to initiate negotiations with Beijing. For their part, Chinese officials have hinted that they may alter their policy at any time but will probably do so in a series of modest steps.

Some economists caution that a change in China's currency regime could boomerang on Washington. That is because under its fixed-rate system, China's central bank constantly buys billions of dollars on currency markets, which are invested in U.S. Treasury bonds and provide a major source of financing for the federal budget deficit. If the flow of money from China into the dollar and Treasury bonds were to dry up, financial turbulence might well ensue, including a sharp upward spike in interest rates.

Questioning whether U.S. officials may ultimately regret prodding Beijing for a rising yuan, Nouriel Roubini, a professor at New York University, wrote on his Web log last month, "The first rule of good manners -- and finance as well -- is that you should not bite the hand that feeds you."

Administration officials have studied the likely financial impact of a Chinese currency adjustment and view the problem as easily manageable. Many independent analysts agree, saying that unless Beijing lets its currency float completely freely -- an almost inconceivable step -- it would have to continue buying large amounts of dollars.

But a more fundamental question is whether a stronger yuan will make much difference to the U.S. economy.