Yuan's Fastest Gains Fail to Quiet U.S. Lawmakers

China's yuan is rising at the fastest pace since the nation's central bank abandoned its link to the dollar in 2005, and U.S. lawmakers still aren't satisfied.

The yuan appreciated 1.5 percent last quarter as prices for items such as food, rent and transportation increased the most in 27 months. Goldman Sachs Group Inc. and JPMorgan Chase & Co. predict that inflation will force America's second-largest trading partner to let its currency strengthen at least 7.5 percent in the next year, more than twice as much as in 2006.

Even that increase would pale next to the 8.3 percent second-quarter rally in Canada's dollar, the currency of the top U.S. trading partner. The yuan's rally has done nothing to curb the trade surplus in the world's fastest-growing major economy. U.S. politicians are planning new duties on exports from countries that use their currencies to put American companies at a disadvantage.

``China's inflation is yet another indicator that the currency needs to appreciate because of the harm it threatens to its own economy,'' said Senate Finance Committee Chairman Max Baucus, a Montana Democrat and one of four sponsors of a bill aimed at fighting currency manipulation. ``Postponing reform is dangerous for China,'' he said in an e-mailed response to questions.

The state-run Xinhua News Agency said last week that the nation's first-half trade surplus may have ballooned more than 60 percent to $110 billion, compared with $177.5 billion in all of 2006.

Faster Inflation

China's 3.4 percent inflation rate in May topped the central bank's 3 percent target for a third month. The consumer price index may rise 3.2 percent this year, the most since 2004, as the economy expands 10.8 percent, the People's Bank of China forecast on June 29.

The yuan closed little changed today at 7.6031 in Shanghai, up 8.9 percent since July 2005 when China ended its peg to the U.S. currency. The central bank allows the yuan to trade as much as 0.5 percent on either side of a daily rate it sets.

A stronger currency reduces import prices and can slow exports, which make up 38 percent of China's economy, according to World Bank data. The U.S. trade deficit with China reached $76.3 billion this year through April, 18.5 percent more than in the same period in 2006. The shortfall was a record $232.5 billion last year, up from $201.5 billion in 2005.

``China's growth is so fast that they want a stronger currency to fight inflation,'' said Yip Ka-Hay, who helps oversee $2 billion of assets as chief investment officer at PMA Investment Advisors in Hong Kong. The yuan will rise as much as 10 percent in the next 12 months, he said.

Goldman Forecast

Goldman Sachs strategists predict the People's Bank of China will let the currency advance 7.5 percent in the coming year, while JPMorgan predicts the yuan will climb 10.6 percent by March. Both firms are based in New York.

``Inflation is going to remain fairly elevated and food is the latest sign of that,'' said Rebecca Patterson, a global currency strategist in New York at JPMorgan, the third-largest U.S. bank.

Food prices increased 8.3 percent in May from a year earlier as factory and apartment projects took over farmland, government figures show. Prices of meat, led by pork and poultry, rose 26.5 percent. Eggs jumped 37 percent and vegetable oil cost 21 percent more. Housing rents climbed 3.2 percent and transport fees 3.9 percent.

Price of Exports

``The latest spikes in food prices have just started to show up in inflation data,'' said Themistoklis Fiotakis, a strategist in New York at Goldman Sachs, the world's most- profitable investment bank. The firm recommends buying the yuan as part of a basket of six emerging-market currencies.

The central bank has increased borrowing costs twice this year, pushing the one-year benchmark lending rate to 6.57 percent. Goldman Sachs strategists say policy makers will lift the rate twice in steps of 0.27 percentage point.

Inflation isn't fast enough to cause China to shift its focus from creating jobs through exports, said Paul Chertkow, global head of currency research at Bank of Tokyo-Mitsubishi UFJ Ltd. in London. In 1994, the inflation rate reached 24.1 percent.

``Anything under 5 percent is fine given the growth rate of the Chinese economy,'' said Stephen Jen, global head of currency research at Morgan Stanley in London. ``Historically, policy makers haven't really reacted before inflation reached 8 percent.''

Pork Chops

Faster inflation is the price of monetary policy that favors exports, said Sun Lijian, an economics professor at Fudan University in Shanghai. The influx of cash from the trade surplus swelled China's foreign exchange reserves by 37 percent to a record $1.2 trillion in the past year and fueled an investment boom that has strained resources.

``China is worrying about agricultural goods prices and whether they'll pass through to other goods,'' Sun said. ``It's a very sensitive factor.''

Xie Qiudi, 44, a saleswoman at a department store in Beijing, said she's dissatisfied with her 100 yuan ($13.16) a month salary increase this year because a bottle of cooking oil that used to cost 50 yuan now goes for 60 yuan.

``Based on my experience, the cost of basic living necessities won't go down once they have increased,'' said Li Baochen, 63, a retired worker in Beijing, who switched to sausages from more expensive pork chops.

`Undervalued' Currency

Senators Baucus and Charles Schumer, a New York Democrat, and Republicans Lindsey Graham of South Carolina and Charles Grassley of Iowa introduced legislation last month that would allow American companies to petition for steeper anti-dumping duties against countries that keep their currencies undervalued.

``We'll know appreciation is enough when we see it,'' Schumer said in an e-mailed response to questions. ``What we are looking for is gradual, regular, measured progress. We know they cannot float overnight, but they can do more than they have done.''

The Treasury Department last month called the yuan ``undervalued'' in its semi-annual review of currency policies. It didn't accuse China of manipulation.

source:bloomberg.com