LONDON (Dow Jones)--As U.S. trade tensions with China ratchet higher, the dollar is only likely to suffer.
Any hopes that China might respond to U.S. pressure by accelerating the rise in the yuan appear as misplaced as ever.As Paul Chertkow, head of global currency research at Bank of Tokyo-Mitsubishi in London, points out, this is because China can't afford to.
"The export sector remains the most dynamic source of employment growth in China," Chertkow said.
"Maintenance of social stability depends on absorption of workers migrating from rural to urban areas and seeking private sector jobs as state-run enterprises are rationalized and/or privatized."
The need to preserve a competitive edge in international markets remains paramount. So, he added, "rather than agreeing to allow the (yuan) to float freely, the Chinese authorities are likely to continue to render the exchange rate regime 'gradually' more flexible."
However, this hasn't stopped the U.S. from piling on the pressure after first quarter data showed that the China's trade surplus nearly doubled to $46.44 billion from $23.31 billion in the first quarter of 2006. The surplus with the U.S. alone rose 21.3% to $34.68 billion.
Last week, the U.S. Commerce Department appeared to have signaled a new line of attack when it slapped duties on imports of Chinese coated paper. For the last 23 years, the U.S. had classified China as a non-market economy exempt from such duties.
This week, the U.S. followed this up with two complaints to the World Trade Organization over the alleged failure of the Chinese to curb copyright violations on intellectual rights and market access for U.S. movies, DVDs, music and books.
Chris Turner, an international economist with ING Financial Markets in London, suggested that this might well be the start of a more "sector/product specific" policy of complaint by the U.S. ahead of presidential elections in 2008.
China itself responded to the shift by warning that the U.S. moves will "seriously damage" trade relations between the two countries.
Officials then promptly turned down an invitations to attend this weekend's meeting of G7 finance ministers in Washington - claiming that they had more important domestic issues to contend with.
China's absence, said Lena Komileva, G7 economist with international brokers Tullett Prebon in London, is "indicative of rising U.S.-China trade tensions."
How large an impact this has on markets remains to be seen.
"The question for financial markets is whether such a localized, sector specific development represents the start of a more hawkish policy on China," said ING's Turner.
There is also the question over whether controlled increases in the value of the yuan since it was released from a fixed peg against the dollar in July last year are now starting to curb export growth.
The most recent data for March shows that China's trade surplus actually fell to $6.9 billion from $23.8 billion in February.
There's certainly little sign that China is about to step on the accelerator and allow the yuan to rise more rapidly. If anything, reported Ashley Davies, a senior currency strategist with UBS in Singapore, "the pace of yuan appreciation has actually eased over the last month to slightly more than 1% annualized in March versus appreciation of around 6% annualized a month towards the end of 2006."
"We maintain our forecast for around 6% appreciation this year for now," Davies added.
Bank of Tokyo-Mitsubishi's Chertkow agrees.
"Despite the protectionist measures, the Chinese authorities are likely to continue to resist calls to allow the (yuan) to float freely against the dollar," he said, forecasting that the yuan will be allowed to continue rising against the dollar by no more than 5.0% over the next year.
Early Thursday, the dollar was trading unchanged at Y119.33 at 0705 GMT, compared with late New York Wednesday, according to EBS. The U.S. currency had been helped by more hawkish-than-expected comments in the latest FOMC minutes, released Wednesday.
However, anticipation that the European Central Bank will signal another hike in rates in the next month or two after its policy meeting later in the day helped to push the euro up to $1.3470 from $1.3430.
The euro's advance against the dollar was also helped by its rally to a new record high at Y160.87 as investors continued to pursue carry trades at the cost of the Japanese currency.
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