Rise of the RMB, Talking Point

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Who gains and who loses from a stronger yuan?

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You gotta help get these guys in Congress off my back”: Obama solicits Hu’s agreement to strengthen currency

Apparently a more cordial chapter in Sino-US relations is upon us. After weeks of barbs and brickbats, the mood appears to be mellowing. Currency policy is shaping the new tone: the consensus is now that it is a matter of when (and not if) the renminbi will be permitted to rise against the dollar.

Some say an announcement is imminent, following Tim Geithner’s whistle-stop visit to Beijing last week, as well as the US Treasury’s postponement of a report discussing China’s designation as a currency ‘manipulator’.

But others think this is expecting too much too soon, especially as Beijing will not want to be seen as reacting to international pressure. Hu Jintao said as much in Washington this week, telling Obama that China would “firmly stick” to its own path in exchange rate policy.

How much is it likely to go up?

That is the other unknown. The last time a revaluation phase was triggered (in 2005) Beijing allowed a one-off jump of 2.1%, followed by a gradual appreciation over the next three years, averaging 6% annually.

This time round the policymakers may be more tentative. Although demand for Chinese exports seems to be recovering, the international outlook is still a lot more uncertain than in 2005. Five years ago, China’s trade surplus was also growing at breakneck pace (not the case today – it registered a $7.2 billion deficit in March).

But good news for the US trade deficit, and for American jobs?

Chinese currency policy is the current bête noire for many of Beijing’s critics in the US, who link it directly to job creation. The gripe is that the yuan has been kept artificially low for years, leading to at least 2.4 million job losses between 2001 and 2008, according to the Economic Policy Institute.

Fred Bergsten, from the Petersen Institute for International Economics, also told a House of Representatives committee late last month that “correcting” the exchange rate is the most effective way to reduce US unemployment. He says that every $1 billion in additional US exports supports 8,000 new jobs. That means that – if the renminbi shoots up the full 40% that the hawks are demanding – well over a million workers will find new employment.

Of course, there is little chance of Beijing signing up to that kind of increase, even over an extended period. In fact, Chinese commentators usually argue that the exchange rate issue is a red herring, and that US policymakers would be better advised to look at other factors in trade competitiveness (like the cost of labour or the impact of American saving and consumption habits).

They claim too that they have the proof that the renminbi is not the primary factor. When the yuan rose 21% against the dollar in the three years from mid-2005 what happened? The US trade deficit with China jumped too – from $202 billion to $268 billion. And it isn’t just the Chinese trying to rebut the view that a stronger yuan will boost American jobs. The US-China Business Council, which represents 220 American companies doing business in China, has also been voluble. The error, the Council says, is to believe that goods imported from China would otherwise be made in the US. Many are not, nor will they be in future. More likely they end up being purchased from countries like Mexico, India and Vietnam.

But there would be winners and losers in the US?

Yes, there would. Some manufacturers will get more orders from Chinese customers now cashed up with a stronger currency. Perhaps India, Mexico and others would let their currencies rise as well (once the Chinese have decided to give it a go), helping overall US competitiveness.

America’s shoppers, on the other hand, may lose out. Stores like Walmart and Target fill much of their shelves with Chinese imports, which would end up costing more in dollar terms. This could hit the ‘real incomes’ of some of the poorer sections of US society.

The basic problem here is that the US imports nearly three times as much from China as it exports there, so it will take a huge boost in exports to offset the impact of higher prices on American consumers in general.

And China’s winners and losers?

Think of it as a mirror image of the US, says Michael Pettis, a professor at Peking University. In America, households will end up paying more for much of their shopping. But in China, they’ll be enjoying cheaper imports. That benefits virtually everyone except “subsistence farmers,” Pettis reckons.

Chinese exporters won’t be quite as happy, as their goods will become more expensive in dollar terms, making it more of a challenge to maintain sales growth overseas. In effect, an appreciating yuan is a transfer of wealth from producers to Chinese consumers – exactly what proponents of a ‘rebalancing’ of the domestic economy have been calling for.

A good thing, then? Not according to some of the local chambers of commerce, who are now talking up the dire consequences ahead if currency policy changes. One group of machinery and electronic manufacturers told New Weekly that they expect profits to halve if the renminbi rises by as little as 3%. Another trade association (representing light industrial companies) was gloomier still, warning the Economic Information Daily that many firms would fail, as profit margins are already thin.

That sounds alarmist (and not necessarily accurate), according to a recent research report from Chinese investment bank CICC. Some companies will benefit from a stronger yuan, especially heavy industrial firms that rely on commodity imports (priced in dollars on international markets, so cheaper to procure if the renminbi strengthens). Purchasers of expensive imported machinery will benefit too. Oil and gas firms, metal processors and miners, and transportation equipment firms will do best.

But CICC also says that some exporters might do better under a new currency regime too. Sure, industries like textiles, apparel and office equipment-makers will be hit. But the overall threat to Chinese competitiveness is being overstated, as exporters will pay less for their imports of parts and equipment.

One example: many of the computers that China exports contain CPUs from the US, motherboards from Taiwan, memory sticks from Korea and hard drives from Thailand. These will all cost less in renminbi terms.

And as the China-denominated expenses are a much smaller fraction of total costs (mostly for processing and assembly), the overall impact on the final US dollar price shouldn’t be much more than a few percentage points. Even this can probably be offset by efficiency savings elsewhere, CICC thinks.

So, the impact may not be huge after all?

It depends how it is handled, says Pettis. It now seems pretty evident that a stronger yuan is coming and that China’s consumers are the big winners. But they will only reap the benefits if they keep their jobs. The risk is that a ham-fisted revaluation might shock the wider economy into a slowdown. Push too fast and consumption growth at home might not make up for any levelling out in exports. Then the wealth transfer from firms to families gets interrupted. In fact, Beijing would face a nasty spiral: declining competitiveness leading to rising joblessness, which results in further falls in domestic consumption, leading to more unemployment. Kiss 8% annual growth goodbye.

Little wonder Hu Jintao told Obama: “China remains determined in the direction of pushing forward the reform of the yuan’s exchange-rate formation.” That’s a statement that commits him to everything and nothing, depending on how you parse it.

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