Behind the lines in China's Currency War

Is China’s free ride on global currency markets in its final lap? Rumors are swirling, in Asia and the West, that a revaluation of the Chinese renminbi is likely by summer.

For nearly a decade, Beijing has parlayed an enormous manufacturing workforce and an undervalued currency, tied to the weak U.S. dollar, into an astonishing export boom. The stunning expansion of its economy – which quadrupled in size in the 21^st century’s first nine years — has hardly been touched by the worldwide economic crisis.

But demands are now accelerating, at home as well as abroad, for the renminbi, better known as the yuan, to be freed from state-imposed restraints.

At a press conference in Beijing on Saturday (March 13), Chinese Central Bank governor Zhou Xiaochuan, his nation’s most powerful financial administrator, openly conceded that the days of the tightly controlled yuan are numbered. The dollar peg is a “special measure,” he said. “These kinds of policies sooner or later will be withdrawn.”

The Chinese government quickly moved to squelch expectations of imminent change, with Premier Wen Jiabao flatly denying on Sunday that the yuan was artificially undervalued. Criticism of Beijing’s monetary policies, he said, was unfair “finger- pointing” by developed countries “for the purposes of increasing their own exports.”

But the revaluation cat was out of the bag.

Pressures for the step to be taken sooner, rather than later, range from an unprecedented trans-Atlantic consensus lobbying for Chinese currency reform —  putting Washington and Europe unambiguously in the same camp for the first time – to hidden structural weaknesses in China’s seemingly robust economy.

Alone, none of these factors is sufficient to budge China’s policymakers. Together, they make a case that Beijing will not be able to dismiss out of hand, whatever its rhetoric to the contrary.

TRANS-ATLANTIC CONSENSUS

For years, Germany stayed clear of the debate over the yuan, while its French and Italian neighbors – like their American counterparts – grew increasingly frantic over the tsunami of Chinese exports.

In the United States alone, incoming shipments of Chinese products soared from $82 billion worth of goods in 1999 to $338 billion in 2008.

From the German perspective, there was nothing to complain about in the strength of the euro relative to the yuan.  A solid, highly valued currency has been tantamount to religion in Germany since the catastrophic inflation of the mark after World War One. Berlin presides over the largest economy in the European Union by far, which gives it implicit control over EU financial policies – and until three months ago, despite the costly euro, Germany was the world’s leading exporter.

In economic terms, it rode the perfect wave: high exports combined with the anti-inflationary power of a strong currency that lowered the cost of materials purchased abroad.

Two developments, set in motion by the economic crisis, have forced Berlin to reassess its position. The first was the near-bankruptcy of profligate Greece, Portugal and Spain, which might have sent the euro spinning out of control without grudging promises of a bail-out by the Germans.

The second was the potently symbolic loss of its league-leading trade position to Beijing in December, following a 45 percent jump in Chinese exports in just one year. Today, says Gernot Nerb, director of industrial analysis at Munich’s Ifo Institute for Economic Research,  “Everyone agrees that China’s currency is undervalued.”

Calls for re-evaluation of the yuan are central to the Obama Administration’s export-led strategy to haul the U.S. economy out of the worst recession in 70 years.

As long as the world is flooded with cheap Chinese goods, the reasoning goes, no other exporter can compete successfully in consumer markets. The crisis might drag on indefinitely, with politically unsustainable levels of unemployment.

The EU and the United States now “have exactly the same position” on the yuan, European Central Bank President Jean-Claude Trichet told Bloomberg News on March 12. “We are conveying the same message to our Chinese friends and this is very, very clear in every meeting that we might have.”

Stark numbers demonstrate why Beijing has little choice but to take such statements seriously. China’s combined sales of goods to the European Union and the United States in 2008 topped $600 billion, amounting to 43 percent of total exports. Its next biggest customer, Japan, imported $116 billion worth of products.

A joint move by Washington and Brussels toward punitive trade action would be significantly more damaging to China than the effects of currency revaluation.

QUESTIONS AT HOME

The new consensus overseas has taken shape, ironically, just as the bargain-basement yuan is beginning to lose support in China.

In effect, some Chinese financial analysts believe – apparently including the normally discreet governor of  the Central Bank – their nation is poised to supplant Germany on the perfect wave.  China needs a stronger currency, they say, to fight off chronic inflation due to runaway growth, and to carry the economy to its next stage of development.

“The country will possibly let the yuan rise in the second quarter (of 2010), suggests Zhu Jianfang, chief economist at China’s state-owned CITIC Securities. This is “mainly because of strong domestic growth, but also because of heavy global pressure,” he says.

“We think the very strong headline export growth will help to address concerns on the negative effect of any currency appreciation from some domestic quarters,” financial analysts Wensheng Peng and Jian Chang wrote in a 2009 report for the Hong Kong Monetary Authority.

China’s productivity is increasing dramatically, and its vast foreign reserves – currently standing at $2.4 trillion – provide an immense cushion against the loss of income from cheap exports.

Currency experts estimate that the potential value of China’s currency is a staggering 40 percent higher than its present exchange rate of 6.83 yuan to the dollar, which is unchanged from a year ago.

In the same year, the currencies of other emerging economies, such as Brazil’s real, South Korea’s won and Poland’s zloty, have floated upward by 30 percent or more against the dollar.

If the yuan were allowed to revalue at similar levels, purchases of U.S. treasury bills – the favorite tool in Beijing’s effort to acquire both foreign reserves and international clout – would benefit from a gigantic de facto discount.

Overlooked in the blizzard of statistics measuring China’s exports of basic consumer goods, moreover, is the fact that it also imports $1.3 trillion worth of resources and technology annually – critical resources it has no other way of securing, and advanced technology that is key not only to its prosperity, but to its very survival.

The end of China’s overwhelming global command in the export of labor-intensive consumer goods is not an “if,” based exclusively on potential currency fluctuations. It is a “when,” an absolute certainty, due to inescapable domestic realities.

UNAVOIDABLE REALITIES

The rest of the world seems curiously blind to these realities, but China’s leadership recognizes them very clearly, and is working desperately to meet them before it is too late.

In a word, they come down to a single problem: demography.

After 30 years of a state policy limiting families to one child, China is faced with history’s fastest-aging and most rapidly plunging population.

The world’s leading manufacturer is running out of workers, with consequences that already signal the demise of its low-wage, underpriced export boom.

Over the past three months alone, the labor crunch has seen industrial wages increase by 20 percent. The New York Times recently reported that hourly pay for unskilled workers in Canton, the fulcrum of the Chinese low-end manufacturing boom, has risen an astounding 50 percent in two years.

No nation in history, not even Japan or Germany in their leap from the ruins of World War Two to the front ranks of global trade, has registered real wage increases to compare with China’s.

Like Japan at a similar crossroads in its evolution, labor-poor China’s only option is to upgrade its manufacturing capacity across the board – and with it the technological level of the economy as a whole.

With the heedless momentum that can only be achieved by an autocratic government, Beijing has responded to this challenge with gargantuan infrastructure projects, building entire new cities, thousands of miles of freeways and high-speed train lines, and scores of engineering schools and universities. Enrollment in higher education ballooned from 2.2 million in 2000 to 6.4 million last year.

The blind spot in its plan has been the yuan, the Chinese leadership’s stubborn insistence on a cheap currency to keep low-quality exports flowing, no matter whose ox is gored.

Beyond the danger of alienating indispensable trading partners, the very means of production today – and any hope of continued economic progress — must be purchased abroad in the form of expensive technology and components.

In the long run, only a strong yuan, fueled by the  promise of a perfect wave, can make that happen.

Frank Viviano – barganews staff reporter – World View CBS5