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Why U.S.-China trade fight is heading to a ‘crisis’ level Add to ...

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U.S, China head for bigger battle Trade tensions between the United States and China are heading toward "crisis" levels, a new forecast warns.

"The U.S. administration is clearly wary of picking a fight with China given the latter's strategic and political significance, which is presumably why the U.S. has shied away from designating China as a currency manipulator for so long," Julian Jessor, the chief international economist at Capital Economics, said in a report today.

"But four factors suggest that trade tensions will continue to build to crisis levels, with 2012 likely to be the crunch year."

Tensions between the U.S. and China have been running high as Washington presses Beijing to allow its currency to rise.

His four factors:

  • The U.S. recovery will be disappointing, with jobless rates still close to 10 per cent and the economy heading towards deflation.
  • Protectionism will soon be the only tool open to policy makers, given there's little hope of further fiscal measures and the Federal Reserves new quantitative easing program will have run its course by mid-2011.
  • China's trade surplus wiith the U.S., which continues to build, makes an "easy target."
  • Politics in both countries hit a turning point in 2012. "The presidential election campaign in the U.S. is likely to be dominated by demands for action against China, but Chinese policy-making will be paralyzed ahead of the leadership change starting that year in Beijing."

Such a trade war would threaten to spill over to other countries, Mr. Jessop said, though he believes Beijing will do just what it takes to stop short of an all-out battle.

"The upshot is that China will probably do just enough to prevent all-out trade war, but only after tensions escalate much further," Mr. Jessop wrote.

"And it will be years before the benefits are felt in a meaningful reduction in imbalances.

"In the meantime, other countries could be dragged into the conflict. For a start, the U.S. might also take action against other low-cost developing countries (citing weak labour and environmental standards), in order to forestall the redirection of Chinese exports to the U.S. vias these countries. Other developed nations may also join any U.S. action against China to prevent the dumping of cheap Chinese goods in their markets."

If all players act properly, the world economy will be stronger, though that won't happen in the next few years.

Bernanke warns on unemployment Ben Bernanke got the markets thinking with comments aired yesterday on CBS Corp.’s 60 Minutes, discussing everything from the country’s jobless rate to the possibility of further stimulus.

The Federal Reserve chairman said in the rare TV appearance that the economy is virtually stalled, it’s possible the central bank could expand its controversial quantitative easing program, and that it could take four or five years before the country’s high jobless rate can be brought to down to its “more normal” 5 per cent or 6 per cent. It now stands at 9.8 per cent after a surprise jump in November.

He did, though, suggest a double dip recession doesn’t appear to be in the cards.

Fed officials have been out in force defending their latest stimulus initiative, known as QE2, a $600-billion (U.S.) asset-buying scheme aimed at driving down longer-term interest rates through purchases of longer-term Treasuries.

“The increase in the unemployment rate to 9.8 per cent has fuelled speculation that there could be further QE or QE3, which seems a little premature given the Fed is only one month into QE2, but comments by Bernanke on TV over the weekend have lent support to this view,” said CMC Markets analyst Michael Hewson.

Global markets mixed Global markets are mixed today as investors digest Mr. Bernanke’s comments. The U.S. dollar climbed, while equities were mixed, with U.S. stock futures pointing to a weaker start.

China’s benchmark Shanghai composite was up slightly, while Tokyo’s benchmark Nikkei and Hong Kong’s Hang Seng dipped. Major European markets were little changed, some on the plus side and some on the minus. New York stocks dipped at the opening. The S&P/TSX composite TSX-I was up marginally.

Europe's debt crisis also continues to weigh on markets.

"Treasuries are rallying and stock index futures are lower amid ongoing concerns about Europe, as Germany continues to resist proposals to expand the European bailout facility or introduce joint euro bonds," said BMO Nesbitt Burns economist Sal Guatieri.

"As well, Moody’s cut Hungary’s credit rating to one notch above junk status. Downbeat comments about the economy from Chairman Bernanke also supported Treasuries, with 10-year yields retracing almost half of last week’s 15-basis-point increase and falling to 2.94 per cent (and still down 90 basis points on the year).

"S&P 500 futures are off moderately after jumping 3 per cent last week to extend this year’s gain to 10 per cent (though still down 22 per cent from the October 2007 all-time high)."

On the currency markets, the U.S. dollar despite the most recent news from the United States.

"The [U.S. dollar] is putting in a strong performance today, gaining against the majors, a surprising development considering Friday’s unemployment data combined with the Fed Chairman’s dovish sounding rhetoric on 60 minutes Sunday evening," said Scotia Capital currency strategist Sacha Tihanyi.

"Risk assets, while under pressure, are not as weak as would be implied by the level of [U.S. dollar] strength."

Would E-bonds fly? European finance ministers are expected today to discuss the idea of creating "the most important bond market in Europe," the concept being the launch of joint European government debt, or E-bonds.

The proposal comes from Jean-Claude Juncker, who chairs the euro zone finance ministers group, and Italy's Finance Minister Giulio Tremonti, who outlined their idea in article they wrote in The Financial Times today.

"In spite of recent decisions by European fiscal and monetary authorities, sovereign debt markets continue to experience considerable stress," the two officials said.

"Europe must formulate a strong and systemic response to the crisis, to send a clear message to global markets and European citizens of our political commitment to economic and monetary union, and the irreversibility of the euro.

"This can be achieved by launching E-bonds, or European sovereign bonds, issued by a European Debt Agency ... Time is of the essence. The European Council could move as early as this month to create such an agency, with a mandate gradually to reach an amount of outstanding paper equivalent to 40 per cent of the gross domestic product of the European Union and of each member state."

Such a move, they said, would allow sufficient size for the market to become Europe's most important, "progressively reaching a liquidity comparable to that of U.S. Treasuries."

Germany, Europe's biggest economy, has already given the thumbs down, while at the same time opposing calls to boost the size of the continent's bailout fund.

From today's Report on Business

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