Analysis: U.S. gives currency diplomacy another chance

A U.S. $100 banknote is placed next to 100 yuan banknotes in this picture illustration taken in Beijing October 16, 2010.

WASHINGTON (Reuters) - The Treasury's currency report delay suggests Washington wants to give diplomacy another chance to convince China it is in everyone's interest to speed up the yuan's rise.

By delaying the report until after a Group of 20 leaders summit in Seoul next month, the United States can defuse some political tension. However, it also puts the onus on the G20 to deliver more than just rhetoric on foreign exchange rates.

Treasury Secretary Timothy Geithner probably won't be winning many friends in Congress, where lawmakers from both political parties back taking a tougher tack on Beijing.

G20 LOOMS LARGER

* Currencies were already front and center at G20 talks after IMF meetings last weekend failed to ease tensions. Forging consensus in such a diverse group will be hard.

* There does not seem to be broad support for a "Plaza Accord" type of agreement on how best to realign exchange rates. European officials have stuck to well-rehearsed statements that excessive currency volatility is unwelcome.

* Geithner toughened his words somewhat last week, saying markets should determine exchange rates.

TAKING OUT THE POLITICS

* Waiting until after the G20 meeting means the Obama administration won't have to reveal its decision until after November 2 congressional elections.

* Although China's currency is not a hot-button issue for voters, it is a source of frustration for unions and manufacturing-heavy states which are typically Democratic strongholds.

* But the delay could spur Congress to act on legislation that would penalize China for keeping the yuan low. A bill that would punish China for its currency practices passed in the House of Representatives last month and two Democratic senators said on Friday Congress was prepared to move ahead with legislation.

* Geithner told lawmakers at a September 16 hearing on China's currency that he shared their frustration with Beijing's slow progress in allowing the yuan to rise. The delay may harden some lawmakers' view that Treasury is too soft on China. The yuan has been the focal point of relations that frequently see tensions over issues from Tibet and Taiwan to trade.

GREEN LIGHT TO SELL DOLLAR

* The delay does little to change the status quo for investors who will be happy to continue selling dollars and buying Treasuries in anticipation of the U.S. Federal Reserve pumping more dollars in the economy.

* It also leaves China free to allow only gradual yuan appreciation and puts upward pressure on the euro, yen and Australian dollar, which as free-floating currencies tend to absorb most of the dollar weakness.

* By managing its exchange rate, China has built up a massive store of $2.6 trillion in currency reserves and is the biggest holder of U.S. Treasury debt. Markets fear a move to label it a manipulator could spark retaliation, with a worst-case scenario involving China selling enough Treasury debt to provoke a sudden spike in U.S. interest rates.

(writing by Emily Kaiser and Steven C. Johnson; Editing by Andrew Hay)