Thursday, May 14, 2009

China should boldly face the threat of currency manipulation label coming from the US

By China Watcher

Every year at around this time, you would be able to hear high handed political rhetoric from the US lawmakers and an incessant stream of anti-China tirades ringing across the floors of the Congress and Senate.

The hottest topic is still the alleged currency manipulation by China. Either the US lawmakers are congregating to try to justify imposing punitive tariffs on China goods which indirectly support the hordes of inefficient and badly managed US’s manufacturers from further revamp and closure or there is a hidden agenda to hold back a rising China.

The accusation of China of keeping the Yuan artificially low is not a new issue but one which was raised countless times by the US politicians since the Bush era. The current US Treasury Secretary has made some remarks concerning China as a currency manipulator when he took office late last year. Since then, he has toned down his aggressive overtures after a meeting with Chinese trade and commerce officials. There will be another round of government to government commercial negotiations in June 2009.

The US lawmakers plan to propose the Currency Reform for Fair Trade Act, which is to counter any currency manipulator nation by allowing the imposition of anti-dumping and countervailing duties on its goods to protect US based industries. Is it not that the US already had existing legislation to bring about fair trade policies and to protect its people from exporting nations?

The question being asked here is “Does China has an obvious advantage in international trade if it manipulates its currency?

First, China does not only trade with the US. It also imports lots of intermediate components from surrounding countries like Japan, Korea and ASEAN to be assembled into finished goods (which is then re-exported to US and EU). The Chinese only makes a small profit margin as a final producer of goods. With the relative lower exchange rate against the US presently, the Chinese would need to pay more local currency to buy the same quantity of intermediate goods. If the Yuan is higher, the producers need not have to spend so much local currency to obtain the same volume of components. The production cost in making the item is therefore lower, making it even more competitive. In the production chain, the actual contribution of the Chinese is in its lower cost of labor of which the US or developed countries will not be able to match.

Second, if China’s currency value (Yuan against US) is higher, it indicates that the US importers would need to pay more US$ for Yuan denominated goods thus making China’s goods more expensive. The US importer which previously imports garment A from China at US$3 per piece would now review its other choices since the price of the same garment A from China has gone up to US$8 (due to the increase in exchange rate). The importer would continue to import from other low cost producing nations like Vietnam, Sri Lanka or India at perhaps, US$7 a piece. The local US producer can only sell the same quality garment at US$12 (due to the higher cost of production). Even if the US succeeds in getting the Chinese to revise upward on its exchange rate, the US would still need to import from other low cost producing countries unless the US would be able to label the other low cost producing nations as “currency manipulator” as well. From the economic standpoint, the US consumers are worse off – they had to pay a higher price for the same quality of goods (US$3 as against US7) – which means a lower standard of living for US residents.

Third, the flow of trade would not just go back to the US if China’s relented to shore up its exchange rate unless the US residents can also adjust to a lower cost of living and/or increasing its level of work productivity. Personally, I think the US residents actually spent more than what they earned which have been happening throughout the last decade. The savings rate in the US society is extremely low. There are just not enough funds to support the the average family expenditure on a rainy day as was observed n the recent financial related crisis. Translated into a macro arena, the outrageous spending by its populace has caused the US economy to be in deficit since the Bush’s Presidency. Is the US single household willing to live a lifestyle similar to a typical Asian household where the apartment/house is much smaller and the car is just a compact? There is also lots of wastage in the US societies. US children are seen to eat only 30-40% of the food served on the table, with the rest going into the garbage bins. If there is going to be any significant decrease in the US’s current account deficit with a heavy reduction in imports (from China), every US individual will need to change their lifestyle. Are there willing to make this sacrifice?

Fourth, politicians felt that is always easy to blame someone when things go wrong and the best possible way is to continue to harp on the low currency exchange and the cheap imports from its top trading nation. China being the biggest creditor to the US will always have to bear the brunt.

As stated before in my article, China must be strong to fend off the heavy rhetoric from these US politicians. It must also accept the fact that one day the US would impose trade protectionist measures on the flow of goods and services between the two countries once the trade friction cannot be managed anymore. A good ongoing initiative taken by China is to diversify its markets elsewhere and reduce the dependence of its exports to the US to, let say, 10% within 10 years’ time. Another suggestive move would be to increase domestic consumption and become less reliance on overseas market.

In the future if those diversification efforts are successful and if these politicians continue to bark, China can just turn a deaf ear.

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