U.S. Warns China on Currency

The Bush administration on Tuesday warned China that it must move “without delay” to overhaul its currency system or face the possibility of economic sanctions.

The warning was the administration’s strongest statement yet that China must stop linking its currency, the yuan, to the weakened U.S. dollar. Critics say that peg gives the Asian nation an unfair trade advantage, adding to a massive U.S. trade deficit with China and causing the loss of thousands of American jobs.

In unusually harsh language, the Treasury Department, in a report to Congress, described China’s 10-year-old exchange rate regime as “highly distortionary” and said it posed a threat to the global economy. Unless Beijing moves to a more flexible exchange rate system quickly, the report said, China is “likely” to be cited for currency manipulation, which would open the door for sanctions.

Treasury Secretary John W. Snow did not cite a deadline for China to take action. Under a 1988 law, the Treasury Department is required to analyze countries’ exchange rate policies and determine whether they are manipulating them to gain unfair trade advantages. Countries found in violation can face economic penalties. The department will publish its next report in October.

Snow said the U.S. wasn’t calling for an “immediate full float” because “China’s banking sector is not prepared. What we are calling for is an intermediate step that ... allows for a smooth transition -- when appropriate -- to a full float.”

Such an intermediate step might entail creating a range in which the yuan is allowed to float against the dollar, analysts have said. The peg now stands at 8.28 yuan to the dollar. It is expected that, if left to market forces, the yuan would rise against the dollar.

The Treasury report triggered a late-day rally on Wall Street as investors saw the statement as a compromise that wouldn’t immediately escalate trade tensions with China, analysts said.

But the Bush administration’s move failed to satisfy manufacturing trade groups and congressional critics, who said that enough evidence existed to label China a currency manipulator. They claim that China’s currency is undervalued by as much as 40%, making Chinese products cheaper in the U.S. and other markets, giving Chinese exporters a huge advantage.

“Getting to the one-yard line doesn’t put points on the board,” said Frank Vargo, international trade expert at the National Assn. of Manufacturers, which called for tougher actions against China. “We need points on the board.”

Chinese officials have said that they are moving toward a more flexible currency regime, but on their own timeline. Chinese Premier Wen Jiabao said this week that currency reform was a matter of national sovereignty and that outside political pressure would not be conducive to resolving it, according to Chinese reports.

Chinese Commerce Minister Bo Xilai told Reuters on Tuesday that the Bush administration’s warning was unreasonable, adding that China was evaluating the Treasury Department’s conclusions.

Speculation has been rampant in recent weeks that Beijing would revalue its currency soon, prompting a flood of investments from traders looking to cash in on a rising yuan. Many analysts still expect China to change its currency policy in the coming months, saying that it would give Beijing greater control over its fast-growing economy as well as soothe hard feelings in the U.S. and Europe.

“China understands the domestic pressure for the Bush administration,” said Zhou Maoqing, a researcher at the China Academy of Social Science, a government think tank in Beijing. “China is determined to reform its currency values, which is beneficial to China too. The key issue is timing. The U.S. exerting pressure will not be helpful but will only make the situation worse.”

For the Bush administration, Tuesday’s report was an attempt to appease its domestic critics without jeopardizing what has become an increasingly important but contentious economic relationship, trade analysts said.

With the American trade deficit with China expected to exceed $162 billion this year, there is mounting pressure from U.S. manufacturers to slow imports from that country. Last week, the U.S. government announced it would reimpose quotas on Chinese-made cotton trousers, knit shirts and underwear.

The European Union said Tuesday that China must reduce its exports of popular textile products or face similar sanctions in that market.

But U.S. companies also depend on Chinese products and components to fill their store shelves and keep their factories running, and cheap imports are credited with keeping inflation low. China is also one of the leading buyers of U.S. Treasury securities, helping to keep American interest rates down.

“The U.S. is trying to buy a little time,” said Morris Goldstein, an economist with the Institute for International Economics, who has argued that China should revalue its currency.

Not everyone is convinced that a yuan revaluation will significantly boost U.S. exports, given the overall competitiveness of Chinese factories and their low costs. Chinese factories often use imported components, which would be cheaper if the yuan strengthened.

And many U.S.-based multinational companies benefit from China’s export advantage because they produce goods in that country for export to the U.S.

William Overholt, Asia policy chair at the Rand Corp. in Santa Monica, said the Bush administration was right to move with caution, given China’s belief that control over its currency is crucial to the stability of its heavily indebted banking system.

“The Chinese see their policy as essential to avoiding an Asian crisis-level banking calamity, and therefore these pressures are a dagger pointed right at their heart,” he said.

Nonetheless, congressional critics from both parties vowed Tuesday to push for tougher action against China. Several pieces of legislation have been proposed, including one that would force the U.S. to impose steep tariffs on Chinese imports if China didn’t revalue its currency within six months.

That legislation got overwhelming support in the Senate last month. But the sponsors agreed to withdraw the measure after the Republican leadership offered to allow a vote on it this summer.

In early June, the Bush administration is expected to rule on a separate petition from Congress to file a currency manipulation complaint against China with the World Trade Organization.

The Bush administration in recent months has raised the pressure on China to revalue its currency, through bilateral discussions and organizations such as the Group of 7. But the administration has opposed calls for economic sanctions, insisting that diplomacy is a more effective tool for moving China toward a market-based currency regime.

At a swearing-in ceremony Tuesday for incoming U.S. Trade Representative Robert Portman, President Bush didn’t mention the new Treasury report. But he chided China for not living up to the commitments that allowed it to enter the WTO in 2001, and his new trade emissary promised a “top-to-bottom” review of U.S.-China commerce.

“When it joined the WTO, China also agreed to the rules of international trade, and it’s in the interest of both China and the United States for China to abide by them,” Bush said.

Times staff writers Warren Vieth in Washington and Don Lee in Shanghai contributed to this report.