(Refiles to add dropped word "has" in first paragraph)
By Simon Rabinovitch
BEIJING, June 11 Like the risk-on, risk-off volatility that has buffeted global markets this year, China's currency policy has been subjected to bouts of pressure and criticism from abroad interspersed with periods of calm.
Beijing is once again facing a pressure-on phase in the cycle, as underscored by U.S. Treasury Secretary Timothy Geithner's harsh words on Thursday about the yuan.
Here are some questions and answers at the current juncture in the long-running yuan debate.
WHY IS CRITICISM OF THE YUAN HEATING UP AGAIN?
In a nutshell, U.S. domestic politics.
With many U.S. lawmakers facing re-election in November and unemployment hovering just below 10 percent, pressure is building on President Barack Obama's administration to push China to break the yuan's nearly two-year-old peg to the dollar.
Although many economists believe yuan appreciation would do little to reduce the overall U.S. trade deficit, a vocal group of lawmakers in Washington says an undervalued currency subsidises Chinese exports at the expense of U.S. firms and jobs.
On Thursday, Geithner struck his toughest tone since the Treasury Department delayed a report due in April in which it needed to decide whether to name China a currency manipulator.
"The distortions caused by China's exchange rate spread far beyond China's borders and are an impediment to the global rebalancing we need," he told a U.S. Senate hearing. [ID:nN10236564]
If the Treasury refrains from punishing China, anger in Washington may only intensify.
Democratic Senator Charles Schumer said lawmakers would move forward soon with a bill that would slap anti-dumping penalties and countervailing duties on goods from China and other countries with "fundamentally misaligned" currencies.
ARE THE CONDITIONS RIGHT IN CHINA FOR APPRECIATION?
The two chief considerations for Beijing are whether exports have recovered after last year's collapse and whether a stronger currency is needed to suppress inflationary pressure.
On the surface, the latest Chinese data argue for a stronger yuan. In May exports surged 48.5 percent year on year, while inflation hit a 19-month high of 3.1 percent. [ID:nLDE65A05X]
But economic facts are never so clear cut.
Inflationary pressures appear to be ebbing, with consumer prices down 0.1 percent in May compared with April.
And the Ministry of Commerce, which has been the most steadfast opponent in the Chinese government of a stronger yuan, believes that exports were flattered by a low base of comparison and have yet to feel the brunt of the European debt crisis.
"Normally, it takes about three months for exports to go from order to shipment and finally to settlement. At present, transactions are still based on orders made in February or March," Huo Jianguo, head of the ministry's think-tank, said.
"We forecast that the impact of the crisis will become clear only in the third quarter," he said. [ID:nTOE65A008]
HOW DO RISING LABOUR COSTS FIT INTO THE PICTURE?
A rare burst of labour unrest in China has halted production at a series of factories, including Honda parts suppliers, and stoked concerns about rising wage costs in the world's largest exporting nation.
Even if there is no nominal appreciation (i.e. the yuan's exchange rate remains frozen), higher wages would, in theory, make Chinese goods more expensive in global markets and hence constitute real appreciation.
Factory strikes are a new development in China, but labour costs have in fact been rising steadily over the past decade. Wages in the manufacturing sector rose 14.5 percent per year from 2004 to 2008 and 13 percent annually in the five years before that, according to UBS estimates.
Relatively stable profit margins and export prices indicate that productivity gains have largely offset higher wages so far.
This could change, at least in the short run, with some firms like contract electronics manufacturer Foxconn talking about doubling wages. But labour typically makes up perhaps 5-8 percent of production costs in China's manufacturing sector, meaning that final prices need not increase much at all.
The upshot is that wage increases are, for now, no substitute for yuan appreciation. But they do give Beijing one more reason for caution in its management of the currency.
Zhang Xiaoji, head of international economics in the Development Research Centre, a think-tank under the cabinet, noted in an official newspaper on Friday that rising labour costs would squeeze exporters' profit margins.
WILL U.S. PRESSURE DELAY YUAN APPRECIATION?
China has repeatedly insisted that foreign criticism is not conducive to a resumption of yuan appreciation, and it appeared to dig in its heels earlier this year when calls from the United States and the European Union were especially loud.
With the euro zone debt crisis taking centre stage over the past two months, complaints about yuan policy have faded away. Some said this presented Beijing a window of opportunity, because it would not appear to be bowing to outsiders.
Many think that the window will be smaller, if not totally shut, as U.S. pressure flares up again.
"One thing is for sure: Schumer's trouble-making won't shake China's determination to promote reform of the yuan's exchange rate regime or the pace of that reform," He Weiwen, an economics professor at the University of International Business and Economics in Beijing, wrote in an official newspaper on Friday.
At any rate, investors expect the yuan to rise just 1.03 percent versus the dollar over the next 12 months, according to pricing in the offshore forwards market. Earlier this year, markets had been pricing in expectations of a more than 3 percent rise. (For more stories on the yuan debate, see [CN-FRX-PLCY-M]) (Additional reporting by Zhou Xin; Editing by Alan Wheatley)