Twice a year, the U.S. Treasury Department releases a report that discusses global exchange rate policies. Recently, it looked more and more likely that the U.S. was going to publish this report dubbing China a "currency manipulator," a pretty serious action it hasn't taken since 1994.
However, Treasury Secretary Timothy Geithner announced late last week that the report would be delayed -- a sign, no doubt, that the U.S. would much rather work bilaterally with China than start a potentially devastating trade war.
Chinese President Hu Jintao is supposed to visit Washington for a nuclear summit April 12th-13th, but you can bet they'll be talking dollars and cents. The outcomes of those conversations could be drastic enough to make you consider their ramifications for your own investments.
Why this time is different
China has long maintained a strict peg between its currency, the yuan, and the U.S. dollar -- one that has kept the yuan artificially undervalued by as much as 25%. This makes the country's exports cheaper on the broad market and keeps their goods competitive. It has also shifted jobs away from the U.S. and has slowed the rebound of other export-driven countries. According to economist Paul Krugman, a revaluation of the yuan would lead to a 1.5% increase in domestic GDP and would improve the "depressing effect" that the yuan has had on the U.S., Japan, and Europe.
But the idea that China's export-centric economy benefits from an undervalued currency is hardly new conversation. So why does this Treasury report matter so much?
- U.S. unemployment has stayed stubbornly high at about 9.7%, while underemployment figures round the 17% mark. Despite the recent recovery, 15 million Americans remain jobless.
- Political pressure is at an all-time high. 130 Congressmen wrote a letter to the Treasury Department expressing concern over "China's continued manipulation of its currency."
- The current policy of passively engaging China has failed. As recently as a few weeks ago, China's Premier, Wen Jiabao, scolded the U.S. and said that China is against countries "pointing fingers at each other." Clearly, the two countries are not on the same page.
These factors, in addition to pent-up frustration on the part of U.S. officials for not being able to connect with the Chinese, has created a sort of populist rigor that tends to blame China for the woes of the U.S. economy.
Unquestionably, the Obama Administration was feeling the weight of American outrage and was, in my opinion, going to force the Treasury's hand in calling China a currency manipulator.
For now, however, the U.S. has found a loophole -- delay the report until President Jintao visits in mid-April. Nevertheless, if talks collapse, expect a quick and calculated response from Treasury officials.
Three possible outcomes
Prolonging the much anticipated Treasury report gives both sides -- China and the U.S. -- the time it needs to hammer out a mutually beneficial agreement. Optimistically, the U.S. could convince China to let the yuan appreciate gradually and on its own accord; China could save face and maintain its pride by avoiding the stigma put forth in a Treasury report. Yet if talks fail, you'd better believe China will be labeled a currency manipulator, at which point several outcomes are possible:
- The Treasury Department comes out with its report and indeed labels China a currency manipulator. This would appease a hot-headed Congress and could possibly accelerate bilateral negotiations in the right direction.
- Negotiations proceed bilaterally with the aid of the International Monetary Fund (IMF). These discussions typically take quite some time and most likely wouldn't bear fruit for months to come.
- Negotiations fail and sanctions are put in place by the U.S. Almost immediately, the Chinese would retaliate, and a trade war would ensue. (Protectionists clang their glasses!)
What it means for you
To be totally honest, chances are good that option three will not occur. A trade war is obviously bad for both countries, as many political and economic issues rest on the shoulders of a healthy Sino-American relationship.
However, let's see what the possible consequences would be if (a) China's currency appreciated, or (b) if talks fail and a trade war erupts between China and the U.S.
First, depending on how much the yuan appreciated, Chinese exporters could see an already thin average profit margin of 1.7% disappear. Given the fact that exporters are operating with an undervalued domestic currency, companies like Mindray Medical
It could also have an effect on large multi-nationals like Wal-Mart
Lastly, if China and the U.S. began imposing sanctions on one another, many American companies could feel the pain of a one-two punch. For instance, large U.S. exporters like Intel
The Foolish bottom line
The fighters were already in their corners, ready for round one of what was shaping up to be a heck of a bout. However, Timothy Geithner rightfully called an about-face before the first punches were actually thrown. Let's hope that in the interim, both sides calm down and realize that untamed rhetoric will only lead to a downward spiral in which both parties ultimately lose out.
Fool contributor Jordan DiPietro owns no shares of any company mentioned in this article. Intel and Wal-Mart Stores are Motley Fool Inside Value picks. Google, Mindray Medical International, and Suntech Power Holdings are Motley Fool Rule Breakers recommendations. The Fool has created a covered strangle position on Intel. Motley Fool Options has recommended a buy calls position on Intel. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy loves a good Bernard Hopkins fight.