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The Nelson Report 9/27 - Political Base Forming for Radical Trade Action on China in GOP Midwest?


Mon.-Tues., Sept. 26-7, 2005




�DO SOMETHING� ON CHINA:
Step one...SHOOT SELF IN FOOT?


SUMMARY: even if the Beijing-sponsored North Korea negotiations seem to be progressing (an important, but not a sure bet), you should worry that US-China relations are headed for an increasingly chilly time this winter, and that things may get uncomfortably hot by next summer...not coincidentally a Congressional/Senate election year. Not only is pressure again building to allow greater appreciation of the RMB, but both Congress and the Administration are working on, or thinking about, potentially severe and costly restrictions on exports to and from China, and the ability of China to invest in the US.

Operating as an emotional overlay to the economic and trade arena is the not-unrelated world of defense and strategic planning. We’ve already seen a relatively subdued, but hard-line DOD report to Congress on “China rising�, and as we noted in Friday’s Nelson Report, the State Department, through Deputy Secretary Robert Zoellick, is trying to channel Administration policy into a tough-love pragmatism, and away from the self-fulfilling negativism to which DOD seems prone. The title of this song is “Waiting for the QDR�, lyrics by D. Rumsfeld, arrangement by M. Pillsbury and A. Marshall.

That’s why China’s continued IPR enforcement failure constitutes a festering wound in bilateral relations, as the infection spreads. Uncomfortable linkages get made. Publicity in the US focuses on Chinese government micro-management and suppression of information on the internet, and the arrest and persecution of journalists, and human rights and labor activists. While decrying the events, critics also claim the “lesson� is that “China could enforce IPR the same way as it cracks down on dissidents, so the lack of IPR enforcement represents deliberate State policy.� The question is raised, “How can you ask us to trust China, on anything, when it does this?�

On currency, China’s policy of minimal appreciation against the Dollar, announced last summer, is seen as “the least they could do, so they did it�. Treasury is once again under the gun to “do something�, as per Undersec. Tim Adam’s “blistering� speech last week trying to shift the spotlight for action on China to the IMF...safe in the knowledge that the IMF isn’t going to touch this one, but in hopes that it will help keep Congress away from a vote this Fall on the Schumer 27% tariff bill, and other, presumably lesser, evils.

When CONOC withdrew, under great pressure, its bid to buy Chevron, one can argue that either it should have been fought-out all the way, to expose the contradictions in US rhetoric and policy, or pulled sooner to avoid the collateral damage. One could even argue that the US should have approved it, but used it as leverage for Chinese movement and concessions in many trade and investment areas. In any event, CONOC ended up a negative for all concerned: the net is Congressional interest in revising CFUIS in ways which would likely severely restrict Chinese investment, despite US investment goals in China...see this Thursday’s Senate Finance Committee hearing.

And the Administration also is preparing bullets which may shoot the US squarely in the foot, while aiming at abuses, real and imagined, by China. Various proposed or discussed export control measures are highly controversial, and some, such as an effort to block “foreign student spies� from US university research facilities would be so stupid, in practical application, that it’s hard to take them seriously.

Today’s message: this stuff is serious as a heart attack and anyone interested in or involved in rational US foreign and trade policy had better jump in with both feet...and even now it may be too late. Of course there are serious, sometimes deadly serious Chinese abuses and threats which must be confronted. The key modifier is “rationally�. This is not lobbying...it is commenting on the asteroid headed our way.
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1. First, on currency, last Friday saw Treasury Undersecretary Tim Adams in the paper for what The Washington Post called a “blistering� speech on the IMF, ostensibly trying to get the IMF to “crack down on countries that engage in currency manipulation�. The “blistering� part was Adams’ charge that the IMF is failing to enforce its own rules against member nations with artificially cheap currencies.

-- some critics said Adams speech was not just intemperate, but showed a lack of sophistication. We disagree. Adams knows that the IMF isn’t about to leap into this briar patch, so his demand is not going to generate actual movement. He also knows that his tough language will help allow Secretary Snow, President Bush and others to look Congress in the eye, rhetorically speaking, as the October/November “deadline� for another currency report comes due.

2. Recall that last Spring, after much delay, Treasury pulled its punch on China, but succeeded in getting the Republican Leadership to put off until the Fall a possible showdown on various bits of legislation trying to force China to revalue the RMB to Congress’ satisfaction. The problem with future deadlines is that they eventually come due, and here we are.

-- if the IMF is feeling generous to the US, and there’s no evidence that this is the case, it might consider a formal investigation of the charge, since that is allowed under the rules, but our sources think this unlikely. In the meantime, Beijing knew it might come in for criticism at the IMF meetings over the weekend, and so allowed a micro-appreciation last week, setting the stage for meetings Saturday between Snow, Central Bank governor Zhou Xiaochuan, and Finance Minister Jin Renqing. Hey...the man’s doing something, OK?

3. Leaning on the IMF also shows that Treasury understands the problem that so long as pressure for revaluation looks like mainly a bilateral US concern, the blow-back gets focused on the US. By shifting focus to the IMF, Treasury reminds Beijing that Europe and Japan have all made strong representations on the RMB...it isn’t just the profligate Bush Administration.

-- looking at China’s actions since it ended the fixed currency ped in July, note that just prior to the IMF’s weekend meeting the daily swing was goosed up a bit...3% on major currencies except the Dollar, which was kept to 1.3%. Still, Wall Street analysts argue, even this small movement should allow Treasury to argue that China isn’t moving toward a more flexible currency over the next few months.

4. However, “they will also be frustrated with their most important concern, the lack of appreciation against the Dollar�, however, warns ISI’s Tom Gallagher. In a report to ISI clients, Gallagher notes that the July move was a 2.1% appreciation, “and now the total appreciation is only about 2.3%.�

-- “China moved from the most transparent currency regime in the world to one of the most opaque [unclear] regimes. It was originally billed as moving from a fixed peg to a currency basket, but it looks more like a managed peg, if there is such a thing.� ISI predicts, “We continue to think China’s total appreciation, including the first move, will amount to around 5%� by next July.

5. We must ask the obvious: is this likely to be “enough� to keep Congressional currency legislation off the books? A former high trade official privately comments that the net of the currency agitation, and rising Hill frustration, is that “it has created a political base of support for radical trade action in the Republican industrial midwest�...a reference to a very active business/industry coalition, including Labor, from many small and medium sized steel and parts plants.

-- the CONOC/Chevron oil deal got caught up in this negative atmosphere, and “fighting CONOC became a proxy for confronting ‘China rising’,� this player argues. As a result, “The White House concluded that it couldn’t overcome objections to the [Chinese] government financing issue, and the Chinese government’s intent [to secure energy for its own use].�

6. So while “there were good economic and commercial arguments in its favor,� the politics of CONOC just got in the way, “and we lost the opportunity to leverage China on all kinds of trade issues.�

-- our source offers an interesting conclusion we’ve not seen before: “this was badly handled by all sides, and it now sits there as a really bad ‘model’ for the next big Chinese investment attempt here.� What worries our source is that CONOC, when added to the Schumer currency tariff bill, and the ongoing absurdity of US visa policies, adds up to a “dishonest US debate on Chinese investment, which is causing China to back-off from planned investment and IPO’s here...check out the rise in IPO’s going to Hong Kong.�

7. As noted in the Summary, CONOC’s fallout includes instant calls to restrict Chinese investment in the US, and there will be a hearing Thursday on whether to amend or strengthen the CFIUS Process. It currently provides relatively narrow grounds for the president to block foreign acquisitions of US companies.

-- Chairman Shelby wants broader grounds for a ban, and Wall Street types are increasingly worried along the same lines as our Administration expert that Congress may be about to establish an anti-China investment regulatory pattern which, once in place, would likely prove both damaging and hard to remove, regardless.

8. There are a slew of potential technology export controls or limits being bandied about within the Administration, with aerospace, computer and machine tool interests increasingly concerned over the trend toward restrictions, in new rules planned by Commerce at year’s end. While only 1.5% of US exports to China currently require licenses, proposals expected would hike that to 10%, or more.

-- while even our math can calculate this leaves 90% free of current or planned restrictions, the very high-profile of Boeing, et al in the US trade deficit battle is enough to induce ulcers amongst free traders. “All the planned restrictions are based on an assessment of the ‘China threat’,� an industry observer source comments, adding, “and of course there is the very legitimate concern about Chinese IPR theft and economic espionage which must be dealt with.�

9. We’d note that since Permanent Normal Trade Relations/WTO membership for China was approved by Congress, the massive US business and industry coalition favoring China has fragmented along “normal� competitive or narrow lines. The net has been less focus and less action in advance of the various restrictions now in the works.

-- however, the increasingly negative implications of DOD’s anti-China tech stance means “industry would hold together against a DOD-led effort to define China as ‘the enemy’ and so to tightly restrict tech transfer, the fact is that everyone is horrified by this drumbeat from DOD, elements of the CIA and FBI.�

10. For those of you keeping a check-sheet, just as USTR and State are working to increase US exports, there are four planned or possible regulatory restrictions coming on exports: first, changing the export control knowledge standard on how to judge criminal intent in cases of economic espionage. Previously, one could draw distinctions between deliberate and accidental transfer...soon, it would make no difference.

-- second, the “deemed export� of technology still in the US, but to which a foreign national has access, will be tightened to restrict access on the basis of birth, not citizenship. This means not just guest researchers, or green card holders, but American citizens born in, say, China, would be banned from access, observers warn. “Do you wonder why so many foreign engineers and scientists are how headed to Canada and Australia,� this source asks...rhetorically.

11. Third, on the surface it makes sense to restrict certain exports to any company or entity controlled by the Chinese military. In practice, the Chinese military and intelligence establishment remain major players, if less directly than before, throughout the Chinese economy. The PLA, for example, is the prime contractor for the Beijing Olympics. This restriction is expected to be released in six weeks. It’s practical ramifications are enormous, especially given that US competitors would not be affected.

-- fourth, perhaps the “most worrisome� rule is a DOD demand that all US defense contractors “segregate� all foreign nationals and get prior US Government approval for any access by any foreigner to any export controlled technology in the US.

12. Sounds sensible, right? Maybe not. As being discussed, this rule would have the practical effect of blocking any US university or research lab with any foreign student from having a contract with DOD (or other federal agencies, depending on the final wording), we are told.

-- as a practical matter, given the pattern of USG grants and funding, “This would block all foreign students to all US university biology, chemistry or physics labs,� warns an industry observer. The good news? “The academic and civilian research labs are on top of this and are really fighting it, in cooperation with the National Academy of Science.�

THAT’S IT FOR TONIGHT....SEE YOU TOMORROW AT THE WAYS & MEANS JAPAN HEARING...



Jim Schollaert
Director of Industry Relations
American Manufacturing Trade Action Coalition
910 16th St. NW, Suite 760
Washington DC, 20006

jschollaert@amtacdc.org
work phone: 202-452-0866, Extension 334
home phone: 703-524-7197
cell:202-412-8594
work fax: 202-452-0739