Zeev's Turnips Patch-No Politics (ZEEV)

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*** China's currency: Renminbi and ruin? ***

By Hussain Khan

TOKYO - Protectionist pressures similar to those visited on Japan in the 1970s and 1980s are growing in the United States to force China to float or revalue its currency. But those advocating a revalued yuan should be careful what they wish for, because they might get it.

Certainly, the world's currency and equities markets have been roiled dramatically since September 22, when the administration of US President George W Bush dragooned the Group of Seven finance ministers into issuing a statement that exchange rates needed to be flexible to reflect economic fundamentals. That statement caused currencies all over Asia to suddenly begin to gyrate.

Is China the culprit it is made out to be? Certainly, powered by cheap labor and an undervalued currency, the People's Republic has been transformed from relative isolation to major global exporter in fewer than 20 years. Because of its flourishing export trade, sniping from competitors has grown, with Western manufacturers accusing the country of remaining relatively closed and cheating on its World Trade Organization (WTO) obligations after becoming a member almost two years ago.

In fact, China, driven under the lash of the former prime minister, Zhu Rongji, has borne a good deal of pain and opened its markets faster than anybody thought possible. Nick Lardy, senior fellow at the Institute for International Economics, told his audience at a recent Merrill Lynch seminar in London that China is "very deeply integrated into the global economy" and "more importantly, deeply enmeshed in the global supply chain".

Import tariffs came down by two-thirds before the country joined the WTO, Lardy said. By 2005, tariffs on manufactured goods will be 9 percent, far below Argentina's, for example, which are in the 20-30 percent range. Import quotas and licenses have all but gone and will be zero by 2005. Moreover, the number of Chinese companies authorized to conduct foreign trade has risen rapidly in the past two years. On Lardy's criteria, China is three to five times as open as Japan. And, while China is running a monumental trade surplus with the United States, its current-account balance is fairly close to even because of its exports from other nations.

The problem with the US manufacturing sector is that it has lost jobs for 37 months in a row - nearly the entire tenure of the Bush presidency - totaling about 2.7 million since July 2000, dragging down the labor market and creating a critical issue in the 2004 presidential race.

Alarm bells have begun to peal in Washington, DC, where both Democrats and Republicans are ever willing to exploit any issue that will give them traction with the voters. Three bills are currently under discussion that are aimed at what is described as China's "currency manipulation", despite the fact that the yuan, known internally as the renminbi, has been firmly pegged at 8.28 to the US dollar for several years. In fact, the United States was eternally grateful during the Asian financial crisis of 1997-98 for China's steadfast refusal to devalue the yuan and kick off a round of competitive devaluations in Southeast Asia.

But China is a big, visible and happily overseas target for US politicians on both sides of the political aisle. More than a decade after US politicians were taking Japan to task almost daily for its then-huge trade deficit, China has shifted into the gunsights. As politicians once bashed Japanese cars on the steps of the Capitol in Washington, it is in the realm of possibility that something Chinese is about to be bashed today.

Since Saudi Arabia set out to punish Western countries for their support to Israel by suddenly raising oil prices by more than 400 percent in the 1970s, the economic growth rate of industrialized countries has dropped significantly, to about 2 percent level on the average. China is the only major country that has posted gross domestic product (GDP) growth of about 8 percent over the past two decades.

The industrialized countries have therefore found trade and investment in China enormously attractive. Industry ministers, prime ministers and presidents have led delegations to China, made agreements and competed with each other to acquire an ever larger share of China's investment market. Various US governments held their noses over China's human-rights record, all the while continuing to accord the country most-favored-nation status, made permanent by the administration of Bush's predecessor, president Bill Clinton. Instead of imposing sanctions, China's human-rights violations have been forgiven in the drive to gain better access to Chinese markets.

As a result of these investment recommendations, China has emerged as a manufacturing giant. The availability of cheap labor has hollowed out some labor-intensive sectors in the industrialized countries and given a competitive edge to all those goods manufactured in China. Labor costs are so cheap that no country in the world can compete with it in export markets. This has caused the rapid growth of capital inflows in China as well as of exports and of foreign-exchange reserves.

Now the time has arrived to suffer the consequences despite the fact that those consequences are going to come back to haunt Western manufacturers. Some 65 percent of Chinese exports are manufactured by Western and Japanese factories, often with components imported into China and then re-exported. Cheap Chinese manufactured products have invaded industrialized countries, resulting in the closure of domestic manufacturing factories.

The constantly widening US trade deficit reached the second-highest level of imported goods on record in July. The trade deficit rose by US$40.3 billion as imports of consumer goods from China and oil hit record highs.

"Big-spending consumers, with refund and refinancing checks in hand, helped push the US trade deficit wider in July as higher imports, largely of consumer goods, outweighed export gains," said Leslie Preston, an economist at CIBC World Markets in Toronto.

Imports of goods and services to the United States rose to $126.5 billion in July while exports also rose, to $86.1 billion, the strongest showing since May 2001. These deficits made the dollar weaker despite the US administration's desire to keep it strong. Sherry Cooper, chief economist at BMO Nesbitt Burns in Toronto, pointed to the 18 percent decline in the US dollar against major currencies such as the euro.

These deficits have resulted in large dollar surpluses in the hands of China, Japan and other Asian countries (see Asia fills her boots: currency reserves skyrocket, July 15).

China's foreign-exchange reserves alone now exceed $357 billion. The only way these Asian countries have been able to use this surplus is to invest it in US government securities.

"Asia's largest economies are aggressively sinking the spoils of their trade surpluses with the United States into the purchase of US government securities, financing much of the widening US federal budget deficit," Peter Goodman of the Washington Post reported from Shanghai.

If the yuan were to be significantly revalued upward against the US dollar, US Treasuries would suddenly become considerably less attractive to Asian central banks, which could go looking for other places to invest. Then the US economic dilemma would rapidly become a whole lot more complicated. The US Federal Reserve would have to raise interest rates to continue to attract foreign investors, who pour $1.5 billion a day into US securities.

So would cutting China's exports by floating or revaluating the yuan create broad-based prosperity or employment growth in the US? Since World War II, the United States has constantly lost industries to overseas competition. US jawboning resulted in the Plaza Accord of 1985 in an attempt to cut Japan's trade surplus. After the Plaza Accord, Japan floated its currency. The yen appreciated, to little effect. US industries, primarily car makers, discovered that now they were competing on quality, not price, and they continued to lose market share.

But it did have one major effect. The Japanese, in a matter of months, transferred much of their industrial plant to the rest of Asia and ultimately provided China with the opportunity to replace Japan as the No 1 exporter. As the Japanese industrial diaspora continued, other Asian countries also made inroads into the US market.

US manufacturing costs and quality problems continued to cost manufacturing jobs. But instead of facing up to their weaknesses, the manufacturers are now replacing Japan bashing with China bashing. A yuan revaluation by as much as 40 percent is being suggested as the competitive tipping point.

But even if that wish materializes, it may be a temporary phenomenon. It is more likely that the same story will be repeated. Japan grew vastly richer on endaka, or high yen, as it was known, exporting the same goods on a higher level of revalued yen until the situation became untenable and Japan endured a crash that it is only now tentatively digging out of.

If under US pressure China floats the yuan, it will have more dollars in its hands and US manufacturers will be unable to reverse the 20-year-old trend of losing to foreign competition. And, because the cost of manufacturing will rise on the upwardly floating currency, the 65 percent of exports produced by Western-owned factories in China will become more expensive and less competitive. Western and particularly US industry would inevitably suffer.

"What an upward revaluation of the yuan could do, however, is firstly make goods more expensive for the heavily indebted American consumer and, more importantly, pull the rug from under China's economic development and integration into the international community," said William Belchere, chief economist at JPMorgan Asia Pacific.

"It could do this at a time of global economic fragility and with serious weapons of mass destruction crisis on its own doorstep, in the form of North Korea's announced nuclear-weapons program."

(Copyright 2003 Asia Times Online Co, Ltd. All rights reserved.

http://www.atimes.com/atimes/China/EI30Ad03.html