Tensions with China Rising

The dollar-yuan was fixed today at CNY6.8015 today. It closed yesterday near CNY6.7750 and was fixed yesterday at CNY6.7768. The greenback's broad rally yesterday contributed to the sharply higher fix today. Subsequently, the dollar eased to almost CNY6.78, generating one of the largest intra-day swings in recent weeks.

News earlier this week that Chinese exports jumped and imports fell followed the disappointing US employment report at the end of last week. Although the two are not really related, the politicos will make the connection nonetheless. Moreover, Washington contacts report that disappointment is growing in the Obama Administration over the less than 1% yuan appreciation over the nearly two months since China says it broke the peg with the dollar.

Ironically, the breaking of the peg may also contribute to less yuan movement going forward if this week's dollar strength continues. However, the currency and trade issues are a perennial source of tension between the US and China. But the sources of tension are not limited to economics. Due to dispute in the South China Sea and the Yellow Sea, it is beginning to look doubtful that China President Hu will visit the US next month as previously anticipated. Recall that a couple of months ago, China dis-invited US Defense Secretary Gates. This is on top of the military-to-military contact having been frozen earlier this year. The Obama Administration's attempt to re-engage non-Japan Asia is running into the bolder assertion of Chinese power, including naval power, in the region.

The military component is one important dimension to Sino-American relationship that was not present in the US confrontation with Japan over its currency and trade surplus. Another important difference, which we have noted before, is the fact that foreign multinational businesses are playing an integral role in China's rapid growth. This was not the case in Japan. This translates into a "natural" allies for China. However, in recent weeks, corporations in the US and Europe have complained about the uneven playing field in China and this is also a growing source of tension.

Early indications today suggest that the WTO is likely to rule against the EU in a dispute with China. It looks as if the WTO will say that the EU's policy of slapping extra duties on imports it considers to be unfairly priced is in violation of the agreement. This case involves the EU effort to impose a 5-year levy on Chinese iron/steel fasteners imports (trade valued at about $750 mln in 2007). If this is indeed the ruling it could have broader implications and force the EU to impose anti-dumping tariffs on a company-by-company basis, rather than an across the board blanket act. This is potentially the first WTO victory for China over the EU.