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U.S. politics clash with reality over China currency

By Stella Dawson

WASHINGTON (Reuters) - U.S. politicians readily muscle up to talk tough against China on the campaign trail, charging its policies undermine American manufacturing, but two key planks of the argument for criticizing Beijing are crumbling.

The Chinese currency has risen 31 percent against the dollar over the past seven years, eroding a chunk of the price advantage Chinese exports once enjoyed on world markets. At the same time, China's huge trade surplus with the world has shriveled.

Yet Republican White House hopeful Mitt Romney says at every turn that as president he would declare China a currency manipulator from day one, and he regularly criticizes Beijing for unfair trade practices.

President Barack Obama, a Democrat, used the backdrop of a lock factory in America's industrial heartland in February to berate China for failing to "play by the same rules" on trade.

Experts say the United States increasingly will have to temper its tone toward China on economic policies - at least behind closed doors - given that the raw argument of currency manipulation no longer holds as much water.

"The U.S. should be praising China for reducing its external surplus so rapidly since 2007," said Nicholas Lardy, a China expert at the Peterson Institute for International Economics.

The head of the institute, C. Fred Bergsten, has been a leading critic of China's currency, saying the yuan was 40 percent undervalued. But Lardy says the gap is now "very modest, not more than 10 percent."

More important is to focus on keeping China's external surplus in check, he said.

China's current account surplus, the broadest measure of its trade with the world, fell by almost one half in 2011 to $155 billion, well below the 4 percent of GDP level considered a benchmark for a balanced external account. That is a big move down from its peak above 10 percent in 2007.

The question is whether China's surplus will remain in check once global growth accelerates. The decline probably reflects a mixture of a rising currency, a shift inside China toward domestic consumption and hence more imports, and sluggish demand from advanced economies for its exports.

The IMF is studying the issue, but Managing Director Christine Lagarde signaled on Thursday that the shift toward more balanced Chinese growth appears longer lasting.

She said it looks as if China's external surplus will be in the 4 percent to 5 percent range, not 7 percent as forecast six months ago, though it could move up again.

"We believe there is more work to be done for the rebalancing to take place, but it is moving in the right direction," she said at a Brookings Institution conference.

The IMF's view is significant because its reading of a 10 percent external surplus had provided a major basis for the U.S. argument since 2008 that China's currency was substantially undervalued.

Already, Chinese Premier Wen Jiabao has signaled that the days of Beijing engineering major yuan appreciation are largely over. He said in mid-March that the currency "is possibly near an equilibrium level" and that China will focus on speeding up work on exchange rate reform - a necessary precursor to floating the currency.

On Saturday, China widened the yuan's trading band against the dollar, allowing it to rise or fall 1 percent from a mid-point every day effective April 16. It could rise or fall 0.5 percent from the mid-point previously.

NEW TUNE

Already the Obama administration has shifted the focus of U.S.-China economic relations away from the currency and more toward the thornier issues of reducing hidden subsidies that make it difficult for U.S. firms to compete for business in China's vast government contracts market. It has also pressed to end rules that require U.S. companies to hand over intellectual property by registering their patents in China.

At the same time, Washington is bringing more trade cases against Beijing and consistently has refused to use its twice yearly foreign exchange report to name China a currency manipulator. The next report was due on Sun day, but the U.S. Treasury delayed its release until after a series of international meetings take place.

U.S. Treasury Secretary Timothy Geithner continues to call for more yuan appreciation. But he too sees a change and told Congress last month the playing field is starting to move in favor of the United States. "We are seeing a very promising shift in the relative competitive position of our economies," he said.

But complex trade issues make for poor campaign fodder.

"The election campaign will cause candidates for many offices from both parties to say simple-minded things about China. Calling for market exchange rates is more complicated than just saying 'China cheats.' So 'China cheats' will continue to be the main message," said Derek Scissors, senior fellow at the Heritage Foundation.

Scissors said the United States should keep up the pressure on China until Beijing does deliver on allowing markets to set the exchange rate. "A higher fixed exchange rate is just a price control at a different level and still a bad idea, no matter what the current account balance is," he said.

Romney, a former governor of Massachusetts who is in line to win the Republican nomination, is heeding that advice.

Asked if the yuan's rise and the disappearing trade surplus undercut the case on currency manipulation, his campaign said:

"Romney is committed to confronting China on these practices, from intellectual property theft, to restrictions on market access, to currency manipulation. If China is still manipulating its currency when Governor Romney takes office, he will take the straightforward step of designating them as a currency manipulator."

Analysts are divided over whether Romney would indeed follow through and whether he would have the grounds to name China a manipulator. Even if he did, it would trigger no sanctions, only talks with China and the IMF.

"The key question is what would happen next," said Scissors.

(Editing by Dan Grebler and Robert Birsel)

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