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Tuesday, November 26, 2002

Business Week Ponders Revaluing the Yuan

Recognising the growing importance of the Chinese economy in the worlds markets, and the vigorous price competitiveness of China's products, Business Week begins to ask itself whether China has some role in explaning the global deflationary environment. But one of the proposed solutions, a revaluation in the Yuan seems of dubious value to BW. As they argue a stronger yuan would make it cheaper for the Chinese to import materials and machinery--which they would then turn into products for export - something Japan once did to good effect. Since the internal Chinese market is not competitive but highly regulated, the Chinese could simply pass on the savings from cheaper import costs in their exported products, making up the difference by charging more internally.

In addition it would take a significant surge in China's currency - something to the order the order of 25% BW speculates - to make much of a difference. But that could spark a financial crisis in China: if a rise in the Yuan were to be followed by a drop in exports then this could wipe out the weakest producers and hammer the banking sector, which is already shouldering some $700 billion in bad loans. all-in-all, not a very clear picture, and not very reassuring for a Ben Bernanke and an Alan Greenspan should they adopt the strategy of going for a significantly weaker dollar.

Four years ago, China figured prominently in the disaster scenarios of some international economists. At the time, South Korea, Thailand, Indonesia, and Russia had all suffered severe currency crashes--and contagion was raging through South America. As a result, China's once-booming export machine sputtered to a near-halt, and its manufacturers were pleading with the government to do something. What would happen if China were to sharply devalue its currency to boost its competitiveness? The result, economists worried, would be another devastating round of devaluations around the world that would exacerbate the global financial crisis. Beijing thought long and hard. In the end, it decided to keep the yuan fixed at 8.28 to the U.S. dollar, to the great relief of the outside world.

These days, Beijing again is coming under pressure to do something about the yuan--still valued at 8.28. But now it faces an entirely different conundrum. Trading partners such as Japan and the U.S. are urging China to let its currency appreciate. Why? Because Chinese factories are flooding the world with cheap goods, everything from televisions and DVD players to bicycles and children's pajamas. At a time when most of the global economy is on its knees, Chinese exports have rocketed by 20% so far this year, while its economy is expanding by nearly 8%. In China itself, overproduction has helped push industrial prices down by 7% over the past five years and retail prices by 10%.

But a growing minority of economists and policymakers are arguing that a deflationary China poses a real threat to the world. "China's prices are becoming global prices," Morgan Stanley economist Stephen S. Roach wrote in a recent report. Chinese prices are already causing imbalances in the developing world. Mexico is seeing the flight of whole industries to the mainland. New manufacturing investment has plunged in most of Southeast Asia. The Japanese are already exploring exporting autos from China. Meanwhile, an influx of cheap Chinese consumer items and foods is raising hackles from Japanese producers. Haruhiko Kuroda, Japan's vice-finance minister for international affairs, warned in mid-November that "China will be exporting price deflation to the other Asian countries" as it produces more sophisticated products.

Kuroda's solution: Revalue the yuan by an unspecified amount. Chinese Finance Minister Xiang Huaicheng says Washington is starting to push similar advice. The idea is to make China's products more expensive, which in turn would curb exports. If only it were that simple. China's competitiveness is so strong that it could easily compensate for a moderate rise in the currency. The supply of $100-a-month Chinese labor is virtually inexhaustible. And $50 billion in annual foreign investment is pouring into China, much of it going to build state-of-the-art factories for U.S., Japanese, and European multinationals. That money is upgrading Chinese industry and boosting productivity by 4% annually, according to the Bank of China.
Source: Business Week

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