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Originally published:
Dec-18-2003
By Hans Belcsák
U.S. Treasury Secretary John Snow trekked to Asia in early September with a weighty mission. His brief was to lobby governments in the region-in particular that of China-to get them to liberate their currencies and let exchange rates respond freely to supply and demand in the marketplace. The underlying assumption is that, if they did so, Asian currencies-and again, particularly that of China-would rise steeply in value against the dollar and U.S. companies would become more competitive internationally.
U.S. industry is suffering. Although the economic recovery in this country is now, technically, in its 22nd month, employment is still declining. More than a million jobs have vanished since the end of the recession, on top of the 1.78 million lost during the eight-month slump. The great majority of these positions were in manufacturing. They did not just evaporate, according to some assessments, but migrated abroad, to countries where wages are much lower and where governments, by keeping the exchange rates of their currencies artificially low, are securing unfair advantages for their producers.
The worst culprit in this respect is said to be China, which has been keeping the yuan hitched to the U.S. dollar at CNY 8.27:USD 1, with a fluctuation allowance of only 0.3% on either side of the peg. The PRC is running a huge and still-growing surplus in trade with the United States, which last year reached an eye-popping USD 103 billion. Because of the corset constraining the yuan's movement, many contend, the currency is now by 30%-40% undervalued. Were Beijing to set it free to float, it would rise quickly and substantially and this would solve many of the trade and jobs problems in America. With next year's elections starting to loom large on the horizon the subject is becoming a hot issue in the United States.
Predictably, though, Mr. Snow, while putting the best possible spin on the results of his efforts, returned from Asia without the concessions he had sought. Beijing told him that, yes, they would free the exchange rate eventually, but not any time in the foreseeable future. So it probably bears emphasizing (a) why it makes sense for Beijing to loosen its currency regimen only very slowly and (b) why the U.S., on balance, might lose more than it would gain if it did succeed in getting China to float the yuan.
In the first place, it is extremely difficult to determine with any degree of certainty whether a currency is wrongly valued, and if so, by how much. To say that the yuan must be undervalued because China is running a large trade surplus with the U.S. is entirely too simplistic. To make a valid comparison one would have to use the trade-weighted effective exchange rates of the yuan and the dollar, not the nominal ones. In doing so, one would have to take into account that China, during the Asian crisis, let the yuan run up alongside the dollar, while most other currencies in the region went through big devaluations.
There are many reasons for the continuing job losses in U.S. manufacturing. They range from dramatic productivity gains to the fact that employment invariably takes a while to pick up after an economic downturn. Companies must be sure that the recovery will be lasting and that their excess capacity is used up before they are prepared to increase investment and payrolls. In most industries, China plays no role in such decisions. Worth recalling, in this context, is that the peak in U.S. manufacturing employment passed way back in 1978, not in recent years, when the U.S. trade deficit with China exploded.
Of course, there are industries in which jobs, and often whole factories, have fallen victim to import competition. Many goods no longer made in the U.S. are now made in China. One needs to keep in mind, though, that China has been attracting brick-and-mortar investment not just from the U.S. and other leading industrial nations, but also from countries in the region and from developing lands elsewhere. A multi-year comparison of trade trends suggests that many of the goods now shipped to the U.S. from China used to be imported from Taiwan, or South Korea, or the Philippines-or even Mexico.
Much more than in the exchange rate, China's advantage lies in a vast pool of inordinately cheap labor. Thanks to this almost boundless resource, the PRC would have little difficulty compensating for, say, a 10% revaluation of the renminbi (Chinese currency) by cutting costs and, thereby, retaining its international competitiveness pretty much undiminished. In the event of a much heftier upgrading, Chinese producers might have to pass on some of it through higher export prices. Rather than triggering substitute production in the U.S., though, this would simply drive up U.S. import costs, not just of toys, plastic goods, and the myriad of other products that the PRC sells in the States in finished form, but also of the materials, parts and semi-manufactures that many American factories bring in for their assembly lines.
A large portion of China's exports, let's not forget, are produced by U.S., European and Japanese companies in the PRC for shipment to their home countries. The consumers in these nations benefit handsomely from the cheap imports. Moreover, China is not by any stretch of the imagination a country that pursues beggar-thy-neighbor policies by keeping its own market closed to foreign goods and services. Under its agreements for WTO membership it is committed to a fairly swift opening up to foreign competition. Imports are already growing quite fast, and they will continue to do so.
If the yuan were cut loose from its tethers and allowed to appreciate, in one fell swoop, by the 40% demanded by some companies here, this could, in the short run, bring the Chinese economy to its knees. If so, it would not only cause severe social disruptions by crippling the country's ability to absorb the millions of workers who are being laid off by troubled state entities or are flooding to the booming coastal provinces from the rural areas of the interior. It would also stall the one reliable engine that is currently pulling along most of Asia-and a good part of the rest of the world.
China is using much of the huge dollar hoard from currency intervention for investment in the United States. Chinese banks bought a whopping USD 41 billion in U.S. Treasury securities in the first six months of this year, thereby aiding in the financing of the U.S. trade and current-account payments deficits. This helps to hold U.S. interest rates down.
The country could not shift to a freely floating FX rate without first making the yuan fully convertible, i.e., removing all the controls on cross-border capital flows. It could not risk doing this while the local banking system is as fragile as it is now. By most private estimates, borrowers in China have defaulted on nearly half of all loans. The main reason why the banks can continue to function is that they are flush with deposits from savers who are among the world's most frugal and have almost no options other than bank accounts for investing their money.
An interesting thought in this context is that if, under these circumstances, all exchange controls were lifted and the yuan were cut loose from its exchange rate moorings, this could unleash such an outrush of funds that the renminbi would plummet in the markets, rather than rise. Perhaps those who have been pushing for a free float should be careful what they wish for.
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Dr. Belcsák is president of S.J. Rundt & Associates, Inc. telephone: 973.783.5206; fax: 973.744.3073; e-mail: info@rundtsintelligence.com; web site: http://www.rundtsintelligence.com/index.asp.
This article appears in the resource library of the FCIB website (www.fcibglobal.com) and is printed with permission of FCIB, an association of international finance, credit and international business executives. The article has also previously appeared in the October 2003 issue of Business Credit Magazine (http://www.nacm.org/bcmag/bcm_index.html).
This information is provided by ABC-Amega Inc. Providing international receivable management and debt collection services for exporters to more than 200 countries including The People's Republic of China. For further information, contact info@abc-amega.com.
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