>DAILY FINANCIAL MARKET COMMENT 02/03/05 Goldman Sachs Economics
>
>*The US trade deficit was $609 billion in 2004 (5.2% of GDP),
>an all-time record. Trade with China accounts for one-fourth
>of the overall deficit, and most of the increase in the real
>trade deficit over the past year.
>
>*As Congress comes back into session, three issues are
>reemerging in Congressional rhetoric that could have a bearing
>on US-China economic relations, particularly with regard to
>trade: 1) legislative pressure to force a revaluation of the
>Chinese remnimbi through increased tariffs, 2) efforts to
>reinstate quotas on imports of Chinese textiles, and 3)
>increasing focus on Asian central bank purchases of US
>Treasury securities.
>
>*On all three issues, we expect Congress's bark to be worse
>than its bite. However, in the short term, rhetoric out of
>Washington -- and particularly from Capitol Hill -- may cause
>concern among some investors.
>
>Trade Deficit with China Draws Congressional Ire
>The US trade deficit was $609 billion in 2004 (5.2% of GDP), an
>all-time record. Trade with China accounts for one-fourth of the
>overall deficit, and most of the increase in the real trade
>deficit over the past year.
>
>As Congress comes back into session, three issues are reemerging
>in Congressional rhetoric that could have a bearing on US-China
>economic relations, particularly with regard to trade: 1)
>legislative pressure to force a revaluation of the Chinese
>remnimbi through increased tariffs, 2) efforts to reinstate
>quotas on imports of Chinese textiles following removal of quotas
>January 1, and 3) increasing focus on Asian central bank
>purchases of US Treasury securities.
>
>1. Chinese currency revaluation: One factor behind China's
>disproportionate contribution to the deficit is its exchange rate
>policy. For more than seven years, China has maintained a fixed
>exchange rate of 8.28 renminbi to the US dollar, which helps to
>keep Chinese export prices low in dollar terms. Although the US
>dollar has depreciated by about 15% on a trade-weighted basis
>over the past three years, this depreciation has come entirely
>against other countries.
>
>Senators Chuck Schumer (D-NY) and Lindsay Graham (R-SC) plan to
>introduce legislation in an effort to force a Chinese
>revaluation. The bill calls for tariffs to be placed on Chinese
>imports if no revaluation occurs within six months after the
>legislation is enacted. While we don't expect this bill to
>become law, we do believe it could see legislative action in the
>Senate.
>
>Senator Schumer introduced similar legislation in 2003, but the
>bill never made it to a vote. The legislation was supported
>mostly by Democrats, who were in the minority then as now.
>However, four Republicans cosponsored the bill in 2003: Senators
>Bunning (R-KY), Dole (R-NC), Graham (R-SC), and Specter (R-PA).
>Their support was likely driven by a mix of general skepticism
>regarding trade with China, as well as concern over the textile
>industry in the Carolinas.
>
>The bill would apply 27.5% tariffs to imports from China, either
>direct or indirect via a third country. The tariff rate is the
>result of taking the midpoint of what the bill's sponsors believe
>is a 15 to 40 percent range of undervaluation in the renminbi. To
>avoid the increased tariff, the Administration must certify that
>a) China is no longer acquiring foreign exchange reserves to
>prevent the appreciation of its currency, and b) that there has
>been a 'substantial upward revaluation' placing it at or near its
>fair market value.
>
>It is unclear exactly how far such legislation might progress
>this year. Senators Schumer and Graham were promised a hearing in
>the Senate Finance Committee on the issue, which is likely to
>take place over the next couple of months. In addition, the bill
>likely will be offered as an amendment to other pieces of
>legislation, raising the possibility of a high-profile vote could
>occur over the next several month. With the expanding trade
>deficit coming into the political spotlight, some senators who
>might normally oppose the legislation could feel increasingly
>pressured to support it. We would expect a majority of Demcoratic
>Senators to vote in its favor, along with a handful of
>Republicans.
>
>That said, Senate passage would be a challenge, and House passage
>would be very unlikely. So while the bill may generate headlines,
>it is unlikely to be enacted into law. Instead, the ultimate aim
>of the bill is to increase Congressional discussion of the issue,
>in the hopes of raising pressure on the Bush Administration to
>press for a revaluation.
>
>2. Foreign purchases of US Treasuries: An issue related to
>revaluation of the Chinese renminbi is the increasing focus on
>the purchasing of US Treasury securities by foreign central
>banks, particularly Asian central banks. These purchases are the
>preferred method of currency intervention.
>
>We believe there is unlikely to be any major action on this
>front. A number of Senate Democrats have introduced a bill that
>includes not only the 27.5% tariff against China noted above, but
>also a limitation on foreign purchases of US debt. Under the
>provision, known as the 'Foreign Debt Ceiling Act of 2005,' if
>the net US foreign indebtedness for the preceding 12-month period
>is greater than 25% of GDP, or if the trade deficit is greater
>than 5% of GDP, the U.S. Trade Representative (USTR) must convene
>an 'emergency meeting' and present to Congress a trade deficit
>reduction plan.
>
>We do not expect this bill to see any legislative action this
>year. However, several Senators have begun to discuss the issue
>more frequently. For instance, Senator Sarbanes (D-MD), Ranking
>Member on the Senate Banking Committee, brought it up at a
>hearing earlier this week on the federal budget as a topic of
>major concern. In addition, Senator Durbin (D-IL) and others have
>already spoken on the issue on the Senate floor, and can be
>expected to do so again in coming months.
>
>3. Protection from textile and apparel imports: Quotas on textile
>and apparel imports were lifted January 1, 2005. This was the
>final of three stages of quota phaseouts begun in 1995. The
>categories affected represent approximately 50% of the total 1990
>volume of textile imports, and in many cases include the most
>sensitive products, which were held under quotas for as long as
>possible. The elimination of these quotas has become a sensitive
>issue for many on Capitol Hill, in particular those from heavy
>textile-producing states in the South.
>
>China is likely to be a major beneficiary of this change, taking
>market share from textile and apparel producers in previously
>quota-protected countries. However, China's accession to the WTO
>allows for special safeguards on textile imports from China if
>harm to the domestic industry can be shown. Specifically, the
>safeguard would reinstate quotas at a level 7.5% above the
>average volume over the first 12 of the last 14 months for each
>category of imports deemed to be threatened. Safeguards were
>implemented for three categories in late 2003, and an additional
>category in 2004. Now, the domestic industry, along with some
>foreign producers worried they will be disadvantaged by the
>lifting of quotas, are pushing for implementation of U.S.
>safeguards on a wide variety of Chinese textile imports.
>
>The US entity responsible for approving the safeguard petitions
>-- the Committee for the Implementation of Textile Agreements --
>has decided to evaluate safeguard petitions based on the threat
>of harm to the domestic industry, rather than demonstrating
>actual harm. This issue is currently the subject of legal
>proceedings, which have delayed a decision on the first round of
>safeguard petitions. Those petitions were to be decided February
>7 or 8, but now are likely to be delayed until later this month
>or beyond.
>
>On all three issues, we expect Congress's bark to be worse than
>its bite. However, in the short term, rhetoric out of Washington
>-- and particularly from Capitol Hill -- may cause concern among
>some investors. We do not expect Congressional rhetoric to
>translate into a change in the Bush Administration's position on
>the dollar. However, the political forces that are driving
>lawmakers on Capitol Hill cannot be completely ignored by the
>Bush Administration.
>
>Alec Phillips