special reports

Dollar Slips as US Imposes Sanctions on China - More to Come?

Friday, 30 March 2007 16:52:07 GMT  |  Kathy Lien, Chief Strategist

In a major shift in US trade policy, the Commerce Department has announced that they will be imposing tariffs on paper imports from China.  After having waited over a year for another major revaluation move by the People’s Bank of China, the US government has decided to take things into their own hands.  Although details have not been fully disclosed, the government is expected to impose penalties in range of 10.9 to 20.4 percent on imports of glossy paper from China. 

Even though US Treasury Secretary Paulson has been in favor of a buddy versus bully approach and China has done their part by taking gradual measures to slow their economy and stock market thorough interest rate hikes and higher reserve requirements, it has not been enough to satisfy the newly Democratic controlled Congress.  The dollar has sold off significantly on the back of this announcement as more protectionism by the US hurts the growth prospects for the US economy.  As much as they are trying to protect themselves, the stock market and currency market seems to believe that they are doing more damage than good.  China’s trade surplus with the US reached $116.24 billion last year, and according to their own figures, glossy paper only represents $81 million of exports.  Therefore the overall dent into China’s trade is small, but symbolically this announcement is quite big because it may be the first step towards sanctions on more important Chinese imports. 

 

Sick of Waiting

 

For the past 23 years, China has been classified as a non-market economy.  Back then, the US government concluded that it was impossible to tell what a subsidy was in a non-market economy, which in essence eradicated the possibility of imposing penalties on imports that was backed by local subsidies.  Last year however, the Commerce Department said that they were reviewing that ruling and could change it in the future.  Despite various measures by China to slow their economy, their trade surplus with the US has climbed steadily every year.  Between 2005 and 2006, the surplus increased from USD$201 billion to USD$232 billion.  In January 2007, China’s 12 month rolling trade surplus hit a record high.  Given the persistent rise in demand for Chinese imports, the US government has decided that they are sick of waiting and are taking things into their hands.  Having only gained power in November 2006, the Democrats are flexing their strength.  One of the top items on their agenda is to reduce the soaring trade deficit.  With many members of the Democratic Senate having screamed about the unfair trade practices of China, it is not surprising that attacking China was one of the first ways to achieve that.

 

First Step towards more Sanctions?

 

As mentioned earlier, the impact of tariffs on glossy paper imports is small, but the initial win for Congress has certainly made it easier for tariffs to be imposed on other imports such as steel, machinery and furniture which represent a far larger portion of overall US trade with China (see table below for the breakdown). The reaction in both the stock and currency markets today reflects the belief that this announcement could set a precedent towards more sanctions in the future.  Commerce Secretary Gutierrez has said that this is an attempt to make things fairer between the two economic partners, and we all know that there are still many things that remain unfair.  China could still appeal the decision, but any appeal is not likely to be passed. 

 

Any Retaliation by China to be Dollar Negative, Yen Positive

 

Instead, China may decide to retaliate by diversifying some of their big war chest of foreign exchange reserves away from the US dollar. The biggest beneficiaries would be currencies such as the Japanese Yen, Euro and British pound.   The inflationary pressures of the tariffs and higher oil prices should keep the Federal Reserve on inflation watch for the time being.  However with the US economy already plagued by the problems in the housing market, and US consumers facing the toll of higher oil prices, at the first sign of trouble, the Federal Reserve may have no choice but to put growth ahead of inflation and look to reconsider their plans to cut interest rates.  Either way, foreign investors need to be even more cautious of being long dollars in the weeks ahead as they watch for any response from Chinese officials.

 

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