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Three Reasons The China Currency Bill Will Backfire (FXI, FXP)

October 6th, 2011

David Zeiler: A Senate bill that aims to restore American jobs by punishing China (NYSE:FXI) for its undervalued currency may resonate with a frustrated American public, but it won’t work.

In fact, instead creating jobs, the bill is more likely to trigger a damaging trade war with China and increase retail prices for Americans – further hurting the consumer spending that has already been undermined by high unemployment.

“This move is idiotic on so many fronts, I don’t know whether to laugh or cry,” said Money Morning Chief Investment Strategist Keith Fitz-Gerald.

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The Chinese have already threatened to retaliate, and Fitz-Gerald says there are three other reasons why China currency the bill will backfire:

  • Tariffs on Chinese goods will raise prices for consumers in the United States, particularly at such retailers as Wal-Mart Stores Inc. (NYSE: WMT) and Target Corp. (NYSE: TGT).
  • China holds $3.2 trillion in foreign reserves, much of it in U.S. securities, while U.S. national debt is over $14.7 trillion.
  • And China’s exports to the United States account for only 4.8% of the country’s gross domestic product (GDP).

“The U.S. Senate has decided to put partisan showboating on the back burner just long enough to craft a bipartisan showboating bill,” said Money Morning Chief Investment Strategist Keith Fitz-Gerald.

Five Republican senators joined 14 Democrats in co-sponsoring the China currency bill.

Of course, it’s easy to see why shortsighted Senators like the China currency bill, which would impose a tariff on imports from countries that fail to address their undervalued currency.

The United States and other countries have long complained that China keeps the yuan undervalued to make its exports cheaper. The $273 billion of U.S. debt China racked up is clear evidence that the country isn’t exactly playing fair.

Furthermore, supporters of the legislation say it would bring home between 500,000 and 2.25 million job, boost U.S. exports, and reduce the federal budget deficit by $850 billion over 10 years. And unlike the stimulus packages of the past several years, it would cost the U.S. Treasury nothing.

But these proponents of the legislation are also guilty of overlooking some fairly important points. The most obvious is that over the past three years the U.S. Federal Reserve has seriously weakened the dollar through its loose monetary policy. And as our largest creditor, China has absorbed the brunt of that devaluation.

And even if the United States did have principle on its side – which it doesn’t – China has made it clear that it will not be bullied by the West into adjusting its monetary policies.

Shortly after the Senate voted 79-19 on Monday to bring the currency bill to the floor for debate, three Chinese government agencies denounced it.

The Chinese central bank said passage of the measure “may seriously affect the entire progress of China’s reform of its yuan exchange rate regime and also lead to a trade war, which we would not like to see.”

Indeed, a trade war is something the global economy, much less the U.S. economy can hardly afford at this time. And by pursuing one, the United States risks undoing all of the progress it’s made up to this point.

After all, the Chinese yuan has gained 30% on the U.S. dollar since 2005. So China is allowing its currency to appreciate – it’s just doing so on its own terms.

Thankfully, the Senate bill is nowhere near law, and many representatives have already expressed reservations about its implementation.

“I’m concerned about the Chinese currency situation,” House Speaker John Boehner, R-OH, told reporters at the Capitol on Tuesday. “But I think it’s pretty dangerous to be moving legislation through the United States Congress forcing someone to deal with the value of their currency.”

The Obama administration has also voiced caution, noting that the sort of retaliatory action prescribed in the Senate bill requires the consent of such international groups as the World Trade Organization (WTO).

So for the time being at least we can chalk all of this anti-China talk up to political grandstanding.

And if you’d like even more insight into China and other growing Asian economies, you should sign up for Keith Fitz-Gerald’s New China Trader newsletter. To subscribe, click here. There you’ll find all of the Chief Investment Strategist’s latest stock picks and advice.

Written By David Zeiler From Money Morning

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