Rise in yuan could hurt U.S.
By Simon Kennedy
Bloomberg News Service
Restive members of Congress are demanding China revalue its currency or face trade sanctions. Bush administration officials are joining the chorus, led by Treasury Secretary John Snow's insistence that "the time has come" for China to move.
Some analysts say they should be careful what they wish for.
While a rise in the yuan may lead to an increase in exports of some American-made products, it may also lead to higher interest rates, leaner stock portfolios, more expensive shopping trips, weaker hiring prospects and lower profits at companies such as General Motors Corp., Wal-Mart Stores Inc., Dell Inc. and Coca-Cola Co.
"Politicians are playing with fire," says Ronald McKinnon, an economics professor at Stanford University in Stanford, Calif. Nouriel Roubini, a former adviser to Treasury Secretary Robert Rubin, says America's reliance on China to plug record U.S. budget deficits means lawmakers risk "biting that hand that feeds" the economy.
China has pegged the yuan at 8.3 to the dollar since 1995, buying and selling it to maintain that level. That means as the dollar dropped 14 percent against other currencies over the past three years, China's currency depreciated by the same amount. China's Deputy Finance Minister, Li Yong, said May 6 that the government is "working very hard" to revise its exchange-rate system, but that no decision has been made on the format or timing of the revision.
Roubini and other economists such as Nobel laureate Paul Samuelson say the peg gives Chinese-made goods an unfair advantage that's led to distortions in global trade. Yet they warn a revaluation would also sting the $11 trillion American economy, which for two years has experienced strong economic growth thanks to low interest rates and solid consumer spending.
American companies such as Bentonville, Ark.-based Wal-Mart and Round Rock, Texas-based Dell, the world's largest personal computer maker, may find the costs of Chinese-made clothes or components rising if the yuan appreciates. Wal-Mart imported about $18 billion of goods from China last year, making the world's largest retailer China's eighth-largest trading partner, ahead of the U.K. and Russia.
The influx of cheap goods also benefits the U.S. consumer, responsible for two-thirds of the economy.
Inflation may accelerate if import costs rise, and that may lead to an increase in interest rates. The cost of Chinese-made goods imported into the United States fell 0.6 percent in the year through March, according to the U.S. Labor Department.
Borrowing costs may also rise if China cuts purchases of U.S. Treasury securities that it buys to cap the yuan's value, bond traders who serve on the Treasury Department's Borrowing Advisory Committee said in a letter to Snow this month.
Chinese holdings of U.S. government securities rose 27 percent in a year, to a record $196.5 billion in February. Both Federal Reserve Chairman Alan Greenspan and economists at Goldman Sachs Group Inc. recently estimated that foreign purchases of Treasuries are keeping market rates as much as 50 basis points below where they otherwise would be.
"China's consumption of Treasuries means yields are lower than they otherwise would be," says Mohamed El-Erian, who manages $20 billion in emerging market debt at Pacific Investment Management Co. in Newport Beach, Calif. "That's been good for the U.S. consumer and also good for companies producing those goods who have been able to avoid a downturn."
Low yields help restrain mortgage and other borrowing rates, which are set in relation to U.S. government securities. A record 6.78 million existing homes were sold last year, helping the U.S. economy grow 4.4 percent.
Companies such as Coca-Cola and General Motors, which have taken advantage of the yuan peg to invest in China, may find it more expensive to do business there. That might pare their profits and ability to invest at home.
A 21 percent gain in China helped Atlanta-based Coca-Cola announce worldwide sales climbed 3.7 percent to $5.27 billion in the first quarter.
An undervalued yuan has also helped Detroit-based General Motors and other U.S. companies who are partners with Chinese firms. GM has teamed up with companies, including Shenyang Jinbei Automotive Co., to open factories in China making Buick sedans, GL8 vans and Chevrolet Spark minicars.
"If the yuan goes up in value, that will eat into the Chinese-generated profits of U.S. companies," says Gary Hufbauer, a former U.S. Treasury economist and now a senior fellow at the Institute for International Economics in Washington. "There is no doubt American firms that have formed joint ventures or have a base in China are quite happy with the exchange rate."
To critics, the yuan peg helped produce a record $665.9 billion U.S. current account deficit last year and encouraged American companies to relocate production to China, contributing to the loss of 1.3 million manufacturing jobs over the past three years.
"China's currency is undervalued and has such a significant impact on trading partners it needs to be adjusted," South Carolina Republican Senator Lindsey Graham said. He has proposed legislation that would impose duties on Chinese imports if the peg isn't changed.
"It clearly is time for the Chinese to act," Snow said. "They have prepared the way, made strides with their financial system and have said they want to do it. Now is the time."
