Yuan A Bet

June 13, 2005
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GRAND RAPIDS — The stock market has been flat since the tech bubble burst. The refinancing wave is over and the real estate market seems to be cooling nationwide. What’s an investor to do? To some foreign exchange speculators, the answer is easy: horde Chinese currency.

The yuan renminbi is literally “the people’s currency” of China. And according to many economists, it is being held at an artificially low value.

Since 1995, the value of the yuan (as it is commonly known) has been set, or “pegged,” at a rate of 8.30 yuan to the U.S. dollar. But as the Chinese economy has taken off in recent years, critics argue, the value of the yuan should have grown, as well. The fixed currency rate, according to opponents such as U.S. Treasury Secretary John W. Snow, gives China an unfair advantage in international trade.

China’s rigid currency regime has become highly distortionary. It poses risks to the health of the Chinese economy,” Snow said in May 26 testimony to the Senate banking committee. “Sustained, non-inflationary growth in China is important for maintaining strong global growth and a more flexible and market-based renminbi exchange rate would help the Chinese achieve this goal.”

Some analysts suggest that the yuan could be undervalued by a rate of 15 percent or lower. American manufacturers claim the number is no less than 40 percent. The Treasury Department, which offered another warning to the Chinese government last month, is inclined to believe the higher number.

“(The U.S. government) wants the Chinese yuan to appreciate by that percentage, in order to make the U.S. exports to China at a more favorable level, at cheaper pricing — which according to the argument would create more jobs back home here,” said Alfred Ho, vice president and head of Asia-Pacific operations for National City Bank in Cleveland. “Now, whether that’s going to happen — and when and at what level — is really the big debate.”

Joining American businesses and the Chinese government among the concerned parties in the debate are currency speculators around the world. Billions of dollars of “hot money” are flowing into China each year, Ho said, as global investors gobble up yuan and “wait for it to appreciate to make big bucks.”

But can China simply wave a wand and transform its exchange rate from 8.30 to 5 yuan to the dollar? Or should it allow the rate to freely “float” as other major currencies do?

“I always ask people to think about what China can afford to do, not what they should do,” said Ho. “Can China afford to adjust its currency by 40 percent? I don’t think so. I personally don’t think so. I think anyone who studies China would come to the conclusion that, no, it’s not going to happen.”

Behind that conclusion are complicated macroeconomic issues.

“The banks are basically insolvent according to western accounting methods,” said Ho. “The banking system cannot take the hit of a more expensive currency. It’s going to crumble. And if the banking system crumbles, everything goes down with it. You have to realize the repercussion of that.”

China now boasts a middle class of nearly 300 million people — roughly equal to the United States’ population. However, the disparity between China’s rich and poor is gaping, Ho said, and growing wider daily. Those who do not fall into the middle and upper classes — roughly 1 billion Chinese citizens — would bear the brunt of the currency correction, he said. The Chinese government would do well to keep that in sight as they consider their monetary policy.

“Everything they are doing is all leading to one goal: to minimize, or control, the possibility of civil unrest,” he said. “If you have 1.3 billion hungry and angry and unemployed people, that’s not a pretty sight. They are trying to tell the international community, ‘Look, we realize there’s an issue here, but we have to do it at our own pace, not just to make someone else happy.’”

Ho suspects that the Chinese government will move to correct the currency valuation later this year or early in 2006. He reckons that the correction will be minor, no more than 10 percent. Nonetheless, that correction should please all parties involved. Speculators will realize a gain (albeit a more modest one). U.S. companies will see a decrease in China’s trade advantage. The Chinese government will improve international relations while preserving civil harmony, not to mention cooling a surging economy.

The only “losers” in the equation are Chinese exporters and the consumers who buy from them.

“You and I would probably have to pay a little bit more at Wal-Mart,” said Ho.    

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