What's Pushing China to Become More Assertive

Chinese yuanChina's rapid economic expansion has been marked with a rise in stature on the world stage as well. But so far, the country that displaced Japan as the world's second-largest economy this year has been careful not to throw its weight around.

However, with its economy growing at faster than 10% a year even as much of the developed world struggles, tensions are mounting. And Beijing now seems to be taking a far more assertive tack, a development that could be crucial for markets as approaching congressional elections in the U.S. set the stage for more confrontation around currency revaluations.

"China has worked assiduously to persuade its Asian neighbors that its rise is peaceful and of mutual benefit," analysts at political risk research and consulting firm Eurasia Group wrote in a recent report about the country's aggressive posture. "But in recent months Beijing has picked fights with nearly every major country in Asia."

Newfound Aggressiveness


Flaring maritime disputes with Japan have led to suspicions that China has banned the exports of crucial rare earth metals are the latest chapter. But friction has been on the rise since the spring, when China provided some shelter to North Korea following the sinking of a South Korean naval vessel.

Tensions along its boarder with India are also mounting, and Chinese troops may be present in the Kashmir region according to some reports.

The newfound aggressiveness may offer investors a glimpse into how China's relationship with the U.S. may evolve as well. The dynamic is especially crucial for financial markets: The U.S. is China's largest trading partner, and China purchases vast amounts of U.S. government debt.

The approaching congressional elections are likely to raise the stakes. Some U.S. lawmakers have long accused China of getting an unfair advantage in world trade by keeping its currency artificially depressed through its largely fixed exchange rate pegged to the U.S. dollar. Indeed, President Obama repeatedly pushed China to let the yuan appreciate at a U.N. meeting last week. But China shrugged off the effort and stuck to its position of letting the yuan appreciate gradually.

Everybody's Doing It


As U.S. elections draw near and the nation's joblessness continues to remain elevated, deeply unpopular incumbent politicians are going to find the idea of an outside agitator increasingly appealing. Singling out China as a currency manipulator, though, is getting harder. After all, Japanese authorities are now actively working to devalue the yen for the first time in six years. South Korea has also worked to depress its currency deeply and gain an edge in exports.

The prospects of further quantitative easing by the U.S. Federal Reserve, meanwhile, have pretty much the same impact. The dollar fell sharply against a basket of currencies when Fed chief Ben Bernanke recently opened to door to more intervention if the U.S. economy were to weaken further.

China may understandably be tired of the perpetual finger-pointing even as countries with far higher standards of living work to effectively cheapen their currency. And the newly assertive posture on foreign policy issues may filter through to currency markets as well.

In the spring, the U.S. Treasury Department sidestepped a decision on whether to dub China a currency manipulator. Such a status could lead to trade sanctions and would have major consequences for markets. Back then, China bought itself more time by indicating a gradual rise in yuan's value was in the cards. But by now, China could be thinking it's time that it stopped getting singled out as a currency manipulator.

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