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Who wins if China revalues its currency?
Leaders around the world -- especially the Bush administration -- are pressuring China to allow its currency to float. Among the beneficiaries if the renminbi is revalued: big U.S. exporters.
By Jon D. Markman
The Chinese currency has become the Bush administrations latest weapon of mass deception in its battle to deflect blame for the nations struggling economy. It seems that on virtually every flip through the three big Cs of televised business, politics and policy news -- CNBC, CNN and C-SPAN -- the Treasury secretary or Federal Reserve chairman is complaining about the value of a monetary unit few Americans have ever seen, much less understand.
Why is the renminbi suddenly the governments new high-value target, and why should you care? Lets start with the big picture.
The U.S.-China trade gap
Just as a bank probably owns most of your house through the value of your mortgage, China increasingly owns a vast chunk of the United States. It is the second-largest holder of U.S. Treasury debt in the world, after Japan, and closing in on the No. 1 spot. They have the money to buy all of that debt because we run a huge trade deficit with them. In 2002, we spent $103 billion more for Chinese-made goods, such as televisions and cell phones, than they spent on U.S. goods like Cadillacs, Twinkies and Spy Kids DVDs.
Government trade officials and corporate leaders believe China should do more to close that gap. A key reason for the trade imbalance, of course, is that the Chinese goods are so much cheaper than equivalent U.S. goods. Were not just talking about electronics and plush toys made by prison laborers for pennies a week, but also agricultural goods. The Associated Press recently reported that low-priced exports of Chinese garlic threaten to doom U.S. commercial garlic production. American garlic sells wholesale for 60-80 cents per pound, compared with 40-50 cents per pound for Chinese garlic, the AP said. The differential: The average Chinese farm worker earns $1 per day, compared with $8.50 per hour in California and $5 per day in Mexico. Dont count on the average Manhattan restaurant owner to buy American garlic out of some Ross Perot-like argument that inexpensive foreign goods will hollow out domestic industries; he needs to maintain profit margins on his meals while costs of things such as health insurance soar.
A partial fix for this problem, some U.S. officials believe, would be anything that would jack up the price of Chinese goods by 10% or more in one fell swoop. The crowbar du jour: Encourage the Chinese government to increase the value of its currency by that amount. The Chinese currency, called the renminbi or the yuan, is pegged to the U.S. dollar at a rate of 8.27-to-1 and does not trade freely on the world market. When the U.S. dollar weakens, as it has dramatically in the past six months, the Chinese currency weakens in value, as well -- making Chinese goods even cheaper than they were previously. Economists, bankers and currency traders believe that the Chinese currency, if allowed to float freely, would rise 15% to 40% against the dollar, giving domestic goods an instant price advantage.
U.S., Japanese, Korean and European finance officials have recently ganged up, privately and publicly, to cajole the Chinese government into, at minimum, shortening the period in which they have promised to let the renminbi float free of its fixed exchange rate. But the Chinese have held fast, insisting that their economy and banking system are too young and too fragile to be subjected to market forces.
Why some say a low yuan is a good thing
The fundamental problem, of course, is that every nation on Earth is trying to export its way to growth at the moment, and its impossible for them to all do so at the same time. Someones got to be a good sport and graciously accept the role of mature importer. As Ross Walker, an economist at the Royal Bank of Scotland, told a reporter for Londons Evening Standard newspaper, The world cannot run a trade surplus with itself.
A vocal cadre of finance-industry pragmatists in the United States has risen to Chinas defense. Tom Gallagher, an international economics analyst at ISI Group in Washington, said he believes that Beijing will act later and do less than its Western trade partners wish. And he thinks that is, paradoxically, a big positive for the United States for two reasons:- First, a higher yuan that made Chinese goods less competitive would provide the Chinese government with less money to buy U.S. debt. A decline in demand would cause Treasury prices to fall, leading directly to the sort of increase in interest rates that could threaten any nascent U.S. economic recovery. (And, as we know, interest rates have been rising of late.)
- Second, the rise in currency value would probably spread to other Asian currencies, harming the competitiveness of manufacturers from Singapore to Korea and stalling their own fragile export sectors.
Stephen S. Roach, director of global economic analysis at Morgan Stanley, further pointed out in a letter to clients earlier this month that the world has formed an erroneous perception that new Chinese companies are capturing global market share with reckless abandon. The truth, he says, is that the rise of Chinese manufacturing is due primarily to the purposeful, voluntary outsourcing strategies of U.S., European and Japanese companies. He notes that Chinese subsidiaries of global multinationals have accounted for 65% of the cumulative increase in total Chinese exports from 1994 to mid-2003, now totaling $365 billion. A high-cost industrial world has made a conscious decision that it needs a Chinese-based outsourcing platform for its own competitive survival, he wrote on July 14. Dismantling the currency peg would destabilize the very supply chain that has become so integral to new globalized production models.
Mark Headley, portfolio manager of the Matthews Asian Funds, said he believes the Chinese will not, and should not, allow the yuan to appreciate more than 5%. China is trying to develop its economy in a stable, sustainable manner by keeping their monetary system carefully controlled -- avoiding the massive new fund flows that could lead to a big boom and an even bigger bust, he said. It is in the process of dismantling a vast state-owned economy, moving hundreds of thousands of people off the government payroll and directing them to the private sector. If its export base were suddenly to lose competitiveness, it risks social collapse. A cheap renminbi is key to the success of one of the greatest social and economic transformations in world history.
Headley points out that a modest 5% increase in the yuan could have a positive effect for American companies. If everyone in China were suddenly 5% richer, they would blow part of their windfall on foreign luxury goods, such as Remy Martin brandy, Shiseido cosmetics and Marlboro cigarettes. Its a paradox, Headley said. On the one hand, manufacturing and services jobs are transferred to China, but on the other hand, its the place where we end up selling a lot of our goods. We want them to succeed, so for now its fair to give them a bit of a freebie with a weaker U.S. dollar.
How to make a buck on a little revaluation, should it come? Figure on a boost in the fortunes of big American exporters such as Procter & Gamble (PG, news, msgs), Altria (MO, news, msgs), Colgate-Palmolive (CL, news, msgs), Caterpillar (CAT, news, msgs) and Viacom (VIA.B, news, msgs). But also lay plans to buy any potential dip in Headleys excellent Asian funds, which will advance in tandem with wealthier Chinese consumers. Conservative investors seeking some exposure to the region should consider Matthews Asian Growth & Income Fund (MACSX), while investors with a longer time horizon who can withstand considerable volatility should consider Matthews Pacific Tiger (MAPTX).
Fine Print
The online editions of Asian newspapers and magazines are writing every day about the debate over the value of the renminbi. Heres an article from The Business Times of Singapore last week. Heres the quote from Federal Reserve Chairman Alan Greenspan in testimony before the Senate Banking Committee that got the world revved up again on the issue. Asked by a senator if China should float its currency, Greenspan said: "I think that from an economic point of view it's going to become increasingly evident that that is what is going to have to happen if the existing cost structures around the world remain as they are. And I think the Chinese are sufficiently sophisticated to understand that." One of the best online sources of Chinese business news is the English edition of Eastday.co, a Shanghai publication. ... The Matthews Funds Web site provides insightful commentary about the region in a monthly newsletter. Matthews Asian Growth & Income has quietly compiled a stellar record. Its up 10% this year but was also up 9% last year, 14% in 2001, 3.4% in 2000 and 49% in 1999. Morgan Stanley economist Stephen Roach regularly provides his views at his companys Global Economic Forum page.
Jon D. Markman is senior investment strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jdm@oddpost.com. At the time of publication, he did not own any securities listed in this column, but portfolios can change at any time.
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