NEW YORK — The growing debate over the almost $150 billion U.S. trade deficit with China has domestic manufacturers, lobbyists and two U.S. senators focusing on that country’s fixed currency exchange rate, which they maintain artificially lowers the price of Chinese goods by as much as 40 percent.

China’s exports to the U.S. have shot up 75 percent since that nation joined the World Trade Organization in 2001, prompting calls for the Bush administration to take a tougher stance.

The demands have caught the attention of Sens. Charles Schumer (D., N.Y.) and Lindsey Graham (R., S.C.) — two men with opposite political alliances but shared concerns on the currency issue — who plan to introduce legislation that would impose a 27.5 percent tariff on all Chinese imports to offset the undervaluation. They want China to allow its currency to float freely, meaning that its exchange rate with the dollar would be set by overall market forces, rather than managed by the central government.

Schumer and Graham hope that floating the yuan would cause it to rise in value from its current level of 8.28 yuan to the dollar, making Chinese exports to the U.S. seem comparatively more expensive. That might slow the loss of U.S. manufacturing jobs and even make it possible for U.S. companies to export more to China.

But experts warn that’s not necessarily what would happen.

Economists determine whether a currency is fairly valued by comparing the cost of a variety of commodity products. China’s current exchange rate suggests that an item that costs $1 in the U.S. should cost 8.28 yuan in China. On average, goods cost less than that, which is why economists consider the yuan to be undervalued by 10 to 40 percent.

But they caution that even currencies that float freely often may be overvalued or undervalued relative to one another. It’s the same effect that tourists experience when traveling abroad. When the dollar is stronger than the euro, a European vacation seems more affordable to Americans. When the euro is stronger than the dollar — as it is now — European tourists find America a more attractive option.

China manages the exchange rate by buying up U.S. currency and debt, and issuing new yuan to pay for those purchases. That has the effect of pushing down the supply of dollars while increasing the supply of yuan. It also means that China has extensive holdings of U.S. currency and treasury bills. According to the National Association of Manufacturers — a lobbying group that’s been particularly vocal in calling for a revaluation of the yuan — China’s reserve of U.S. currency now comes to about $600 billion.

This story first appeared in the February 1, 2005 issue of WWD. Subscribe Today.

At a press conference last month, Schumer said China’s fixed exchange rate cuts the legs out from under U.S. competitors.

“Even with their lower cost of labor, we can compete,” Schumer said. “But once you add another 25 percent to 40 percent advantage, we’re dead.”

The International Monetary Fund has called on China to free its exchange rate from government control, and the topic is anticipated to be a major issue at this week’s meeting of the G-7 industrial powers in France.

During last week’s World Economic Forum in Davos, Switzerland, a prominent Chinese economist from outside the government said he expected China to move this year to repeg the yuan to a basket of currencies, including the euro and Japanese yen as well as the dollar.

While China has resisted the U.S.’s calls to move on the currency, he suggested the weakening dollar could prove a liability to China by making more expensive its imports of raw materials and other items necessary to industrialization.

“The U.S. dollar is no longer a stable currency,” said Fan Gang, of the National Economic Research Institute at the China Reform Foundation on Wednesday. “Chinese authorities will not forget it. Now people understand the U.S. dollar will not stop devaluating.”

However, Chinese Executive Vice-Premier Huang Ju noted on Saturday that China must strengthen its banking sector and further open its capital markets before it can allow the yuan to float more freely.

Not all experts shared Fan’s faith that China would move quickly to change its exchange rate.

Wilbur Ross, chairman of International Textile Group, said, “I don’t think it’s realistic that they would make such an adjustment that it would change things. They are well aware of the effects the exchange rate has and they like it that way.”

The dollar’s slide has been most pronounced against the euro. On Monday, the dollar was worth 77 euro cents, down from the all-time high of 1.21 euros set in October 2000.

A Treasury Department spokesman last week declined to comment specifically on the potential peg of the yuan to a dollar-euro-yen basket, but said the U.S. is pleased by any move the Chinese make toward loosening control of their currency. However, he said the administration still believed that China’s ultimate goal must be to allow the yuan to float freely.

Representatives of domestic manufacturers had a similar response.

“If they’re going to maintain a peg, I’d much rather have them peg toward a basket of currencies, not just toward the dollar,” said Frank Vargo, vice president of international economic affairs at the National Association of Manufacturers.

Vargo said if the Chinese lifted controls on their exchange rates and allowed their currency to float freely — as most countries do — “it would be a very positive effect” for American manufacturers.

“I think we would see a pretty rapid effect, with our exports to China growing more rapidly,” he said. “We would also see a significant slowdown in the rate of imports from China.”

The trade imbalance between China and the U.S. isn’t limited to the apparel industry. While China is the U.S.’s leading supplier in those categories, holding 17.6 percent of the import market for the 11 months ended in November, its $13.5 billion in shipments represented less than a 10th of the $179.18 billion in merchandise the U.S. imported from China over the period. By comparison, U.S. firms exported $31.46 billion worth of goods to China in that time frame, leading to a $147.71 billion goods trade deficit with China, according to Census Bureau data.

That made China a significant contributor to the U.S.’s $561.33 billion overall trade deficit, which includes the trade in goods and services with all countries. Over the first 11 months of last year, net U.S. exports of $43.99 billion were dwarfed by the $605.32 billion in imports.

Domestic executives contend revaluing China’s currency would go a long way toward offsetting the deficit, though some believe that will prevent the Chinese from making any major currency moves. The National Council of Textile Organizations joined the NAM last year in filing a petition calling on the federal government to act to investigate China’s currency policies.

“China’s currency manipulation so distorts the free market that literally no other country can compete today with China’s exports,” said NCTO president Cass Johnson at the time.

The groups shelved their complaint in May after the Bush administration informally indicated that it wouldn’t  pursue the issue.

The more gradual shift to the dollar-euro-yen peg might cause the yuan to rise in value by 4 to 5 percent over a year, said Fan, the economist.

Importers acknowledged that a step as radical as that being proposed by Schumer and Graham would have a pronounced effect on trade.

“It would limit the sourcing that we would be doing there,” said Joe McConnell, vice president of strategic sourcing at Kellwood Co. “In a sense, it would have an impact similar to what quota had in the past.”

Even the NAM’s Vargo, who has been among the staunchest opponents of the yuan peg, said: “We welcome the senators’ fervor on the issue,” but “we can’t support it, because that would be a huge, massive walking away from our world trade obligations and the world trade system we created.”

Economists also criticized the notion, and many suggested that a revaluation of the yuan would not have an as pronounced result on the trade balance as many industry executives believe.

“Schumer’s proposal is a terrible idea,” said Andrew Bernard, professor of international economics at Dartmouth’s Tuck School of Business. “A bilateral trade imbalance with China is not the kind of thing you want to use to make policy. If we have a trade surplus with a country, you don’t want them placing a tariff on us.”

Ira Kalish, global director of consumer business at Deloitte Research, also said it would be a bad idea to impose a tariff to compensate for the fixed exchange rate.

“So much of what they export is reprocessed imported components,” he said. “If they revalue the currency 20 percent, that doesn’t mean the price of exports will be up 20 percent. It would probably be much less because only a relatively small share of the value comes from China. A lot of it is imports that were brought in, processed, then reexported.”

For instance, many electronics products are assembled in China of circuit boards and other components that are manufactured elsewhere in the world. This is less true for apparel, since many Chinese manufacturers are vertical — they spin their own yarn, weave their own fabric and then manufacture the clothes.

ITG’s Ross said China’s large reserve of U.S. currency provides a further disincentive for it to float the yuan.

“If they were to revalue their currency 40 percent, they would then incur a loss of 40 percent of whatever their holdings are,” he said.

China’s investment in U.S. dollars and Treasury securities also has the effect of limiting the U.S. government’s leverage on this issue.

“If foreign lenders like China don’t finance our deficit, we will have to finance it by borrowing from private investors, who would require a higher rate of return,” said Deloitte’s Kalish. “If they stopped doing that, the dollar would fall a lot more and would lead to higher long-term interest rates.”

Economists suggested the exchange rate is little more than a spoiler issue, disguising what they consider to be the real problem — the rising U.S. deficit.

“The fact that we have a current-account deficit is not because of the Chinese. It’s because of our own choice as a society to consume more than we produce,” Kalish said. “It would be foolish to think that a Chinese revaluation alone would correct our current-account deficit.”

The rising U.S. deficit — which stood at $561.33 billion through the first 11 months of 2004 — has become the subject of concern for many in the international community. In a report released last week, the U.N. Conference on Trade & Development said the deficit would be unsustainable and posed a risk to the world economy.

Bernard of Dartmouth also pointed out that the result of China releasing control of its exchange rate might not be a rise in the value of the yuan.

“It’s a mistake to think that if China allowed its currency to float and be determined by the market that it would strengthen against the dollar,” he said.

That’s because, in addition to controlling its exchange rate, the Chinese government has strict rules in place about the flow of capital into and out of the country. If Beijing relaxed those rules, it could prompt Chinese citizens to pull their money out of China and invest it in Western markets that offer far more investment options than are available in China.

Experts also noted that one reason China has been so keen on keeping the value of the yuan pegged to the dollar is that it encourages the development of labor-intensive export industries. Those jobs are critical in a country of 1.3 billion people, many of whom are migrating from rural farming communities into cities in search of work.

Bernard Yeung, a professor at New York University’s Stern School of Business, said he considers the yuan to be undervalued by 15 to 20 percent, but he believes that, if the yuan were allowed to float freely, it could overcorrect, shooting up by as much as 25 percent. That could lead to a wave of closings of Chinese companies operating on thin margins and prompt a rise in unemployment.

“What the world doesn’t want is another Asian financial crisis, especially not at this time,” Yeung said. “We need to think big, in the geopolitical sense. Stability in that region is vital….The Chinese government’s legitimacy is based on the economy doing well, based on people’s satisfaction with the economy. If people are not satisfied, who knows what might happen?”

A Growing Gap: U.S. Imports of Chinese Textiles and Apparel, and Net Trade Deficit 2001-2004

2004* $13.5 billion $31.46 billion $179.18 billion $147.71 billion
2003 $11.61 billion $28.37 billion $152.44 billion $124.07 billion
2002 $8.74 billion $22.13 billion $125.19 billion $103.06 billion
2001 $6.54 billion $19.18 billion $102.28 billion $83.1 billion