China and the New Congress

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China will allow its currency to appreciate 5% against the dollar in 2011, the semi-official Chinese Security Journal said in a front-page editorial Wednesday. Who cares? Currency valuation seems like the furthest issue from people’s minds in Washington as the new Congress turns to looming battles over health care and the budget. But China trade policy is lurking just below the surface as power shifts in DC and could affect Americans more than any other issue in coming months.

In September, the Democratic controlled House passed by 348-79 a bill that would punish China for keeping its currency artificially low. The bill would force the administration to impose punitive tariffs to offset the harm caused to American exporters by currency manipulation. The Senate never moved the bill, but Charles Schumer introduced his own version that would be even tougher on China.

Traditionally this is a Democratic issue: labor unions are big backers of the House bill; the Chamber of Commerce opposes it. But the shift in political power to the right in Washington may actually aid the bill. China’s increasing power was the key foreign policy issue in the 2010 campaign, and populist Tea Partiers, in search of a foreign policy consensus, seem more likely to partner with Democrats backing the bill compared with pro-business Republicans who have opposed it.

The administration has been increasingly hawkish on China’s currency position in public, but privately it fears a trade war if the bill passes. Among the possible reprisals by China: a fuller implementation of China’s “indigenous innovation” policy, which would cut American companies out of bidding on Chinese manufacturing contracts; reversing recent decisions to open up Chinese markets to beef and other U.S. exports; restricting the export of rare earth metals and so on. None of which would be good for the economy as it struggles to recover.

China’s apparent move to appreciate the Yuan was timed to warm relations ahead of the State visit later this month of President Hu Jintao, and officials at Treasury and the White House are pleased. It may decrease demands for early action on the currency bill in Congress. But no one yet knows how the newly strengthened GOP in Congress will handle the issue.