Perhaps it is a bit cynical to suggest that this week's visit to China by Senators Charles Schumer (D., N.Y.) and Lindsey Graham (R., S.C.) is grandstanding. But it does appear that they used the trip to provide cover for delaying a full vote on their bill, which would impose a 27.5% tax on all Chinese imports if China does not allow the yuan to appreciate significantly with six months of passage of that bill. Recent comments from both Schumer and Graham have been somewhat more conciliatory, even though both men continue to express some criticism over the pace of the move. A formal decision is expected next week as to how the senators will proceed, but there are strong indications that they will postpone the consideration of their bill until at least late April. Two key events will take place in April, and one has to suspect that a vote on the bill before these events will not be helpful:
People's Republic of China (PRC) President Hu will visit the U.S. and meet with President Bush and several other top officials. The U.S. Treasury will issue its report on currency market manipulation. I have consistently argued that the likely decision to cite China as a currency-market manipulator is largely meant to deflect or steal the thunder of more protectionist measures being considered by the U.S. legislative branch. Such a citation is largely toothless, as it requires bilateral negotiations, but it might be sufficient to demonstrate to Congress that the executive branch will ensure that the PRC moves in the right direction. Schumer was very clear: Events over the next "month or so" likely will determine whether he pushes for a vote on his bill. Surely most reasonable observers would recognize that China has taken steps to build the institutional capability and mechanisms that allow for a more flexible currency. For example, since the market-maker system was introduced earlier this year, the pace of yuan appreciation appears to have accelerated, and the volatility appears to have increased. The real problem then is the pace of change -- not the direction.
The direct market implications are slim to none (while some people say the yen was sold Thursday on the Schumer-Graham comments, I am not sure). Over the past six months, there was no meaningful correlation between the Chinese yuan and Japanese yen, for example. In that time period, the Asian currencies that show the highest correlation with the yuan are the South Korean won and the Taiwanese dollar, but in both cases the correlation is less than 0.3 (with 1.0 being a perfect correlation). Indirectly, one might argue that the risk of U.S. protectionism was a background negative for the dollar insofar as a trade war would risk the smooth financing of the U.S. current account deficit. However, the dollar's permabears -- who place an emphasis on the U.S. current account deficit -- are unlikely to change their minds simply because one of many protectionism bills that are at different stages in the legislative process will be delayed. In some ways, the most dramatic development over the past week or so regarding the U.S. and China is the Bush administration's National Security Strategy, which seemed to argue that China's action or indeed lack thereof is a threat to U.S. national security. Chinese officials have protested such claims. The fate of the dollar remains more in the hands of the Federal Reserve than in Beijing or in the halls of the U.S. Congress. As long as the Fed continues to raise rates and brings the market (kicking and screaming) to appreciate the magnitude and duration of monetary tightening that is necessary to address the current inflationary risks, the dollar will be a better buy on dips than a sale on rallies. Indeed, my view remains that we have yet to see the dollar's cyclical high.