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Revaluing the Yuan
Posted by: Dale Franks on Thursday, May 12, 2005

David Francis writes in the Christian Science Monitor that currency traders, economists, and import/export firms are all asking the same question: When will China Revalue the yuan?
It takes 8.28 yuan to buy one American dollar. China has kept it at that value for more than a decade by buying up dollars on the foreign exchange market when demand for the dollar is too weak. Most big nations allow their currencies to "float" according to supply and demand in the market for currencies. This has some economic advantages.

"It's something [the Chinese] really have to do at some time," says Romeo Dator, portfolio manager for the U.S. Global Investors China Region Opportunity Fund, based in San Antonio. "But it is a question of when. They would really like to surprise people."

The United States and Europe have been pressuring China to revalue its currency. They see a flood of inexpensive imports from China damaging their firms and costing jobs. In the US, the April employment report showed another 6,000 manufacturing jobs gone.

But the Chinese government doesn't want to be seen as being forced to act by Western pressure. Nor does it want to damage its vital job-creating export industries with a too expensive yuan.

So the guessing game continues.
Don't expect too much movement too fast, no matter what China does. China's number two currency guy, Wei Benhua, says that fully floating the Yuan in the FOREX "may take decades".

Or maybe not. As Mr. Francis points out in his essay, when Mexico tried to do a little revaluing of the Peso, they got hammered, and the value of the peso collapsed.

China's problem is that it needs export-led growth. Despite all the talk about "1.2 billion consumers" in china is hogwash. No one has made any real money in China's consumer economy yet, because the vast majority of Chinese can't find the financial wherewithal to consume much of anything beyond subsistence. Don't let pictures of huge skyscrapers and office blocks going up in Shanghai or Beijing fool you. Most of China is still back in the 19th century. Or earlier.

Until China's economy has grown enough from exports—which provide 30% of China's economic growth—China won't have enough wealth to support a consumer-driven economy, and they know it. The reason they've maintained such a firm peg of the yuan's value to the dollar is because it allows them to export cheaply. Raising the value of the yuan makes their exports relatively more expensive, which means slower economic growth.

For our part, China's firmness in keeping the yuan valued steadily means that the Chinese have been buying up massive amounts of US debt. Yes, one can make the argument that Chinese imports cost US jobs. But one can also make the argument that Chinese willingness to support US debt issues also creates jobs—at least for the last decade—while we spend more than we make. If the Chinese stop underwriting US debt, that party will certainly be over.

A relative dearth of buyers for debt issues would certainly send interest rates higher. That tightening of credit would result in slower US economic growth. And, with Chinese imports becoming more expensive, we could expect an uptick in inflation, which would probably help drive interest rate increases as well, as lenders factored in increased inflationary expectations.

How many jobs would that cost as the economy slows, one wonders? It may be hard to come up with an exact figure for that, but it would almost certainly be a number that is exponentially larger than the number of job losses in the textile or light manufacturing industries that we lose from Chinese imports.

And that's the trouble, politically. We can see job losses from high levels of imports right now, and that creates political pressure for protectionism. What we can't see is the level of future job losses caused by slower economic growth. Those remain purely hypothetical. So the political pressure is to ignore the future complications that might arise, in favor of pressuring the Chinese to make a policy change now. So, essentially, by pressuring China to revalue the Yuan, we are trading the prospect of saving 150,000 textile jobs now, for losing 3,000,000 or so jobs across the board in an interest rate-driven recession in the future.

Oh, and by the way, it's our own darn fault. The only reason that it's a problem is because we've been spending money—both public and private—like drunken sailors on a Singapore shore leave for the last decade, while our Chinese friends have smiled ingratiatingly, and unhesitatingly reached for the bill. We've run up a massive current account deficit as a result.

In other words, the problem isn't that heathen foreigners have come in and undercut our prices. The problem is that we have been spending recklessly, both in terms of public and private spending, and have racked up a spectacular amount of debt.

As long as someone else is willing to pick up the bill, well, the party can keep going. Economic growth looks spiffy, and we can keep buying neat stuff.

But what do you do when it's your turn to pick up the check?

So, we're in a bind. We want China to revalue the Yuan just enough to take some political pressure off, and to cut imports a little bit. But, we don't want them to revalue it enough to force us to make a serious effort to clean up our balance sheets. And, fortunately for us, the Chinese want the same thing, because they need the export-led growth that will help them—hopefully, eventually—to create a consumer economy. At the moment, our interests are in rough alignment.

But currency moves for Third World countries—and make no mistake, that's what China is—are notoriously unpredictable. Just as Mexico got hammered in the peso collapse, the late 90s were a period of horrific devaluations of several Asian currencies. As soon as FOREX traders thought they caught a hint of weakness, they pounced on those currencies, driving the value down.

So, if China tries for a modest revaluation of the yuan, we all better hope that the FOREX market doesn't begin to smell blood in the water. because if they pounce, China's first reaction will be to prop up the value of the yuan by selling off its dollar denominated securities. And they've got a lot available to sell off. Such a sell-off, in turn, could cause a sharp spike in interest rates as a glut of bonds hit the markets, looking for buyers.

So, if China does start looking at a revaluation, here's to hoping they can pull it off without a hitch.
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Previous Comments to this Post 

Good piece, and I agree with the conclusion, but you got a couple of important technical points wrong. First, you say that "Lowering the value of the yuan makes their exports relatively more expensive, which means slower economic growth." You mean "raising the value of the Yuan". Second, you seem to treat the government budget deficit (public overspending) to the current account deficit. Although there are some connections between the two (if there were no cumulative budget deficit there would be no government debt for the Chinese to buy to prop up the dollar), the current account deficit is the result of spending more on imports than we earn on exports, so that would exist even if the budget deficit were lower or nonexistent. There is a good analysis of the renminbi (yuan) and the current account deficit in the May 6 issue of John Mauldin’s newsletter, (free registration required).
Written By: Terry Dugan
URL: http://
Approval of a nation’s attempt to export its way to prosperity seems to me a very unlibertarian gesture.
Written By: Bob Dobalina
URL: http://
Let’s not make the mistake of thinking that if the Chinese cut back on bonds we’ll all of a sudden go into freefall. The reason the Chinese and other foreigners are buying so many bonds is because American are finding better returns for their money. This is a good thing.

If the Chinese shun our market, yields will rise and other buyers will step in. These things tend to balance each other out. The mistake we sometimes make is assuming the reason the Chinese are buying our bonds is because we don’t have the money, but we do. We just choose to chase higher returns.
Written By: spongeworthy
URL: http://
I suspect that China will want to revalue the renmindi in the near future in any case. Why? Because of their growing need for imported oil and energy fueling their economic activity. By undervaluing their currency, they have to pay more for energy imports than if they let the currency markets set parity.

Energy is the underpinning of every industrial economy. Without adequate supplies they return to agrian poverty. You can see China’s concern for energy supplies in their naval expansion and their foreign policy initiatives. Someday soon they will find themselves facing the same constraints as "normal" developed countries and find they can no longer play the "little guy against the First World" games.
Written By: Whitehall
URL: http://

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