March 26,2010

Yuan Appreciation Never More Necessary or Better for China

By CSC staff

Although a Chinese official in Washington DC has vehemently defended the yuan, insisting China's currency is not undervalue, Beijing may already have reached a conclusion that yuan appreciation, by exit from its US dollar peg back to its "managed float" before the financial crisis, will not hurt the economy. The Chinese government should well see by now that appreciation better serves China's economic and political interests.

 

When the government said this month that its trade is facing an US$8 billion deficit, it was still telling the US Congress that the yuan was not undervalued and should not be forced to appreciate.

 

The $8 billion deficit, however, actually justifies yuan appreciation in that it can help Chinese manufacturers deal with the inflationary pressure of energy and natural resources imports.

 

China, the world biggest steel maker, has been squeezed, both by anti-dumping and other protectionist policies on its steel exports and by skyrocketing iron ore price hikes. For the 2010-2011 period, the world's three giant iron ore miners, BHP Billiton and Rio Tinto of Australia and Vale of Brazil, may have agreed to an 80-100 per cent hike, a record price increase for iron ore suppliers. The price hike and the new spot-based pricing mechanism will make Chinese steel makers even more vulnerable to iron ore miners. China spent $50.14 billion importing iron ore last year, more than any nation.

 

If China's import price increases faster than its export prices, it follows that yuan appreciation makes Made-in-China better off. The stronger purchasing power will hedge the risk of China's exports growing more costly. 

 

Consumer benefits, cheaper imports, stronger purchasing power, and a better-equipped macroeconomic policy toolkit: all are benefits rarely mentioned by government officials and media.

 

According to a recent China International Capital Corporation research, the number of industries that would benefit from yuan appreciation, especially those industries dependent on commodity imports such as those in oil and gas, chemicals, metal processing, transportation equipment, and metals mining, exceeds that of those that would take a hit from it. Even export-dependent industries such as electronics, electric equipment, and general and special machinery will benefit from yuan appreciation as the cost of importing materials will decrease, and the gains from selling in the domestic market will more than offset any export losses.

 

Yuan appreciation has never actually hurt China's exports and employment. Since the yuan's previous de-peg from USD in July 2005, it has appreciated by 17.5%, but China's export market share has continued to grow, defying even the financial crisis.

 

The strongest anti-appreciation noise comes from labor-intensive and low profit margin industries. But even China's clothing and shoe exports may benefit from appreciation in value terms. In the US market, clothing and shoes from China and Mexico, two arch competitors, take market shares of 46% and 37%, respectively. Although the yuan has appreciated against the peso since 2000, China's US market share for clothing and textiles increased from 21% to 48%. From September, 2008 to March, 2009, in the midst of the financial crisis, the yuan appreciated against the peso by 39% and hurt the cost advantage of Chinese exporters, whose clothing and shoes market share declined from 46% to 42%. However, once the yuan/peso exchange rate stabilized, China's exports rebound rapidly and its market share bounced to higher than before the crisis.

 

Even if yuan appreciation causes a shock to China's labor intensive industries, it will be very short term. Since China's inland provinces lag far behind coastal provinces, a disruption to coastal labor-intensive industries can be a catalyst to relocate to less developed regions and help balance out China's manufacturing economy.

 

These are all reasons why some Chinese executives are joining U.S. President Barack Obama in backing a stronger yuan, even as Premier Wen Jiabao insists the currency isn't undervalued.

 

Yang Yuanqing, CEO of Beijing-based computer maker Lenovo Group, Ltd., says appreciation would boost consumers' purchasing power. China Merchants Bank Chairman Qin Xiao says an end to the yuan's 20-month peg to the dollar would allow lenders to set market-based interest rates. Chen Daifu, chairman of Hunan Lengshuijiang Iron & Steel Group, says a stronger currency would cut import costs.

 

Though such comments contradict Wen's statement, who said on March 14 that criticizing the exchange-rate policy amounted to "protectionism," they are in line with traders who expect the government to allow the yuan to appreciate later this year. And international pressure won't go away. U.S. lawmakers have called on President Obama to use the threat of trade sanctions to force an end to the currency regime that they blame for making their nation's manufactures uncompetitive.

 

"We need to emphasize the benefits of yuan gains," said Vice-Chairman Zhang Yanling of the Bank of China, the nation's largest foreign-currency lender, said in a March 19 interview. "The U.S. should also be talking about both aspects of the issue. We shouldn't politicize it or become emotional."

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