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Wednesday March 29, 2006 - 15:07:12 GMT
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Forex: Grassley-Baucus Bill Makes For More Activist US Currency Policy

Senators Grassley (R-IA) and Baucus (D-MT) introduced a bill aimed at not just forcing China to allow markets to set the yuan level (higher), but to more broadly set in place a new review process for the US Treasury and Congress to monitor the currency market and address currency misalignments early and with concrete consequences.

The motivation for the new legislation is twofold.

First and foremost it is aimed at elbowing out the potentially ruinous Schumer-Graham bill in the Senate ahead of the mid-term elections. Make no mistake about it, Congress will pass a new trade/currency bill this year ahead of the mid-term US elections to go on record that it is protecting US jobs - the Dobbsian effect (no not that Dobbs, rather as in Lou Dobbs, CNN Americas xenophobe masquerading as a news anchor).

Unlike the Schumer-Graham bill there is no nuclear option - the 27.5% tariffs the bill would impose on all imports from China unless China revalued its currency (to be imposed 24 months from when the bill is enacted into law). It is also worth noting that the Bush administration surely played a role in encouraging Grassley and Baucus to generate a competition bill that is considerably less protectionist than the Schumer-Graham bill.

And the bill calls for a new Assistant Treasury Secretary for FX (doubt either Senator's staff came up with this on their own...Treasury fingerprints are all over this bill IMHO) and a role for the IMF in penalizing countries whose currencies are grossly misaligned (Treasury has been pulling the IMF into global currency enforcement role - like WTO is for trade IMF would be for forex) as G7 seems utterly incapable of agreeing on FX misalignments outside the yuan.

Secondarily, the bill is aimed at fixing what is now a very limited and ineffectual trade bill from 1988 that only has consequences for extreme situations where a major trading partner is determined a currency manipulator in twice-yearly reviews by US Treasury. The label is rarely applied and when it is applied it is toothless (Clinton Treasury named China, Taiwan and South Korea manipulators in 1994). It is also observable that China is not overly concerned with being named a manipulator again in the late-April report from US Treasury otherwise more movement up in the yuan would be tolerated if not outright orchestrated by the PBOC.

The bill also opens up the Treasury FX policy review net to bring in more currencies and countries where currencies are misaligned. The bill implies a more activist currency policy at US Treasury at the behest of Congress. Again a more activist Treasury in currency matters is in my opinion something the Treasury is quite happy to do if it checks the far more dangerous protectionist drift represented by Schumer-Graham.

I can easily see the yen (not a typo) being described as a misaligned currency...large bilateral trade surplus with the US and a history of government manipulation of the currency mainly in periods of a rising yen. Look ahead to the fall, after the bill passes. US auto companies in or near Chapter 11. Japanese auto sales in the US at a record high and Toyota highly profitable. The Japanese economy exiting deflation and on a sustained growth track with rising domestic demand. Japan monetary policy tightening. Japanese officials regularly warning the government is prepared to intervene if yen volatility is high and if yen does not reflect fundamentals (as Japan's government sees them). And dollar/yen? Trading 115-120. The fact that Japan has not intervened openly since March of 2004 will not matter much when it comes time for Treasury to report to Congress on misaligned currencies, even if officials never get around to the question of proxy intervention through government and quazi-government agencies like Kampo). The bar for a misaligned currency country is far lower than that for a currency manipulator country.

And the new lower bar for FX assessment could conceivably name a freely floating currency as other words the market has overshoot and does not reflect fundamentals. How about euro/dollar this fall at 1.20 and the bilateral deficit bloating, ECB tightening, Euro Zone expansion broadening?

Sure the teeth of the bill will not impact developed trading partners like Europe and Japan when it comes to incentivizing governments to correct major currency misalignments the way they would with less-developed trading partners like China. But developed-country currencies tend toward flexible regimes and hence just a mention of misalignment by US Treasury could conceivably get the market's attention and the desired result when there is little chance of producing a significant policy shift in named country.

Between what Congress and the Bush administration are up to on currencies, one thing is clear...G7 is being marginalized as the steward of global FX/trade adjustment. What appears to be emerging in its place is a new monitoring/incentive system with a greater unilateral role for US Treasury (mandated by Congress) and a greater multilateral role for the IMF.

David Gilmore


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