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A Strong Yuan? Careful What You Wish For

John Lee

On Oct. 3, the U.S. Senate overwhelmingly endorsed opening debate on imposing tariffs on imports from countries with undervalued currencies. On the following day, Federal Reserve Chairman Ben S. Bernanke added more fuel to the fire by claiming that Beijing’s currency policies are preventing a more rapid rise in Chinese domestic demand, thereby hurting American and global growth.

The disagreement over currencies is ultimately all about jobs. Washington wants to increase the competitiveness of U.S.-based manufacturing while Beijing is determined to protect its export manufacturing sector, which employs between 150 million and 200 million Chinese workers. Even though it is undeniable that Beijing is suppressing the yuan against the greenback through a number of market interventions (mainly through the purchase of dollar assets and restricting the convertibility of the yuan), Washington is putting too much blame on China for its unemployment woes.

In fact, China’s currency policy is actually good for American consumers and bad for their Chinese counterparts. And a sudden upward revision of the yuan would do little to help U.S. employment. Chinese economists, including several from the People’s Bank of China, argue that the cost of Beijing’s currency policies is starting to outweigh the benefits. Although China has huge net export surpluses with America, it has reasonably balanced trade relationships with most other countries. China has become a net importer of many basic staples, such as grain and soybeans, and is also a net importer of such fuels as oil and natural gas. With inflation running near 6 percent, allowing the yuan to rise at a level that is closer to the market rate would help keep prices from rising too quickly.

Moreover, the primary structural imbalance within the Chinese economy is the fact that domestic consumption as a proportion of Chinese GDP is around 33 percent—the lowest of any major economy in the world. The figure in India is around 60 percent and in the U.S., 70 percent. With fixed-investment rising to an unsustainable 55 percent of GDP, encouraging more domestic consumption has been a major priority in the last two Chinese Five Year Plans (2006-10 and 2011-15). Given the increasing reliance on imports, raising the value of the yuan against major currencies would increase the purchasing power of Chinese consumers.

EMPHASIS ON JOBS

Yet preserving jobs matters more to China’s leaders. Compounding the problem: China’s 130,000 state-owned-enterprises (SOEs), which receive around three-quarters of all bank loans each year, are extremely inefficient at job generation. Directing more capital to China’s five million private enterprises would enhance job creation and raise the mean disposable income throughout the country—since more ordinary citizens would share in the fruits of economic growth. Doing so would allow net disposable incomes, and therefore domestic consumption, to rise significantly. But this would mean diluting the economic power of SOEs and therefore the political influence of the Chinese Communist Party.

Whereas Chinese consumers are hurt by Beijing’s currency policies, foreign companies and American consumers are the beneficiaries. U.S. outrage at Chinese currency policies is driven by an outdated and inaccurate view of modern-day trade that sees American companies hiring American workers to sell products to Chinese consumers, and vice versa, Chinese companies employing Chinese workers to sell products to U.S. consumers. In such a model, the artificially low level of China’s currency obviously gives Chinese businesses an unfair advantage.

The more complex reality, however, is that foreign companies use China as the central hub of processing trade. China is a nation of 1.3 billion people, but the size of its domestic market is about the same as that of France’s: significant but far from dominant. Instead, about 75 percent of intermediate goods imported into China come from the rest of Asia, and about 60 percent of the finished products go to non-Asian OECD countries—mainly the U.S. and the European Union. For instance, Chinese workers add only 1 percent to the value of Apple (AAPL) iPods even though the finished product carries a “Made in China” tag. More generally, Chinese workers add between 10 percent and 20 percent to the value of most goods shipped out of the country.

WHO WOULD WIN

Significantly, almost 84 percent of import and export Chinese trade is conducted by foreign-invested companies. In other words, in a world where manufacturing processes and assembly is globalized, foreign companies and international investors seeking the cheapest and most efficient manufacturing avenues are the big winners from Chinese suppression of the yuan. In turn, Western consumers benefit by paying less for goods partially assembled by what is effectively an underpaid Chinese worker.

If China were to increase the value of the yuan rapidly, multinationals would do one of three things. One, they could retain the current structure of the assembly chain and pass on the higher cost (resulting from the higher yuan) to U.S. consumers. Two, they could relocate part of the assembly chain back to the U.S., which could help create some jobs—with the higher cost borne by the American consumer. Most likely, though, companies would just move to other low-cost countries, such as Vietnam, Indonesia, or perhaps India. If so, few new American jobs will be created.

The prospect of 1.3 billion Chinese consumers voraciously consuming U.S.-made products is seductive but still fantasy. Instead, Washington should be careful what it wishes for. If China floats its currency, a more expensive plasma television rather than a new job for an American worker could be the more likely result.

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