Fisher Investments Editorial Staff
Currencies, Media Hype/Myths, Emerging Markets

Whose Side Are Yuan?

By, 04/06/2010

Story Highlights:

  • There were high hopes a Treasury report would identify China as a currency manipulator, forcing its government to let the undervalued yuan appreciate, supposedly benefitting US businesses.
  • The Treasury announced it will delay releasing the report until after high-level executive meetings between nations, preferring resolving the issue diplomatically.
  • Though the awaited Treasury report is delayed, a yuan appreciation isn't out of the picture—it may actually be in China's economic interest to do so.
  • Yuan appreciation can help limit Chinese inflation, but not hinder its economic growth, which can continue to help drive global growth.
  • A diplomatic solution is better than starting a possibly messy trade war with negative ramifications for both sides.

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The renminbi has some seeing red, claiming alleged Chinese currency manipulation renders the US an economic disadvantage—but is it worth all the fuss? Politicians, economists, and industry groups had high hopes a Treasury report identifying currency manipulating countries would include China, with the public declaration forcing its government to let the undervalued yuan appreciate. However, the Treasury announced it will delay releasing the report until after upcoming international summits and meetings with Chinese officials. Diplomacy is the game today, not a heavy fist—and that may actually move China further towards a freer currency faster.

Opponents of current Chinese currency policy argue a cheap yuan bolsters Chinese exports at the expense of American businesses, citing the number of jobs lost in the manufacturing sector and the huge trade deficit between the countries. Yes, manufacturing jobs have been on the decline, but there's also been tremendous job growth in the services and technology sectors—a workforce transition frequently seen in developed countries. (All the while, US manufacturing continues to be tops.)

Whether yuan manipulation is the reason for the lost jobs is hard to pinpoint—a slew of emerging market countries are also home to cheap labor, a function of lower labor costs tied to lower standards of living. Plus, when China let the yuan appreciate more than 20% from 2005 to 2008 after removing a strict dollar peg, the US-China trade deficit rose from $201 billion to $266 billion in the three years—suggesting revaluation is less impactful than assumed.

Though the awaited Treasury report is delayed, a yuan appreciation isn't out of the picture—it may actually be in China's economic interest to do so. Many countries manipulate their currency to some degree to help domestic economies, but such policies provide both benefits and drawbacks. Often, those choosing manipulation place greater importance on the benefits, but that doesn't always mean the benefits outweigh the drawbacks, economically. In China's case, a lower yuan versus the US dollar helps increase exports and foreign currency reserves, but at the expense of depressed domestic consumption, increased vulnerability to global economic downturns, and handcuffed monetary policies.

Now that China's economy is heating up, so are inflation prospects. To rein in its growing money supply, China could significantly curb lending growth, reduce fixed asset investment, or let the yuan appreciate. The first two solutions would also undesirably reduce economic growth, but yuan appreciation could help limit money supply growth and boost domestic consumption, reduce pressures from external debt, and strengthen the financial capacity of Chinese companies abroad. This would help the Chinese economy to continue chugging along and benefit other global exporters.

Today's diplomatic solution plays to the politics of both sides. The US avoids having to label China a currency manipulator and starting a possibly messy trade war with negative ramifications (perhaps serious ones) for both sides—while China can take a measured approach to currency appreciation in its own interests, pleasing its critics without being forced into action. Note, China is a global economic powerhouse, but its economy and capital markets are still very much developing, and China remains reliant on US dollar reserves for stability. The two countries may be vocal denouncers of each other's various policies, but in the end, neither wants to upset the yin and yang-like balance the governments have created.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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