Executive Briefings

The Yuan's Too Weak - But It's Not the Real Problem

Oh, for a world of easy answers. We'd all like to see China boost the value of its currency because that would help U.S. exports, right? Well, yes - but what about all those unintended consequences?

Start with the fact that China won't do anything just because the U.S. tells it to. Who's holding most of the cards in this relationship, anyway? China has been financing our budget deficit for years now, and has stockpiled huge reserves of dollars. Moreover, it's the favorite place for American manufacturers in search of cheap labor, at least for now. So why should China take steps that would theoretically bolster markets for U.S. goods while making its own products less competitive?

Few would disagree that China has been artificially manipulating the yuan to keep it weak against the dollar. Granted, it let the currency appreciate by around 21 percent over a three-year period, but it has kept the yuan in the neighborhood of more than 6.8 to the dollar since July 2008. U.S. legislators have threatened to take punitive action, in the form of a bill that would allow for the imposition of duties in response to the yuan's continued under-valuation. The Obama Administration, especially Treasury Secretary Timothy Geithner, has spoken out on the issue, although in less combative terms. (It's more apt to make the argument that an abnormally weak yuan hurts other emerging market economies even more than it does the U.S.) And the International Monetary Fund recently urged China to let the yuan appreciate, to cool an expected growth rate of 10 percent this year.

With rampant growth comes inflation, and that's the reason why China will finally relax its grip on the yuan just a bit. The nation has done a fairly good job of controlling inflation during its dizzying expansion of recent years (again, let's give a big thanks to our U.S. manufacturers for that windfall), but it's looking at a rate of better than 5 percent by year's end, according to some experts.

The prospect of higher inflation will put China's central bank at loggerheads with the ministries in charge of promoting exports. The former is likely to prevail to at least some degree, without any help from the outside world. So doesn't that solve the problem, from the standpoint of U.S. interests?

It depends on who those interests are. Certainly, U.S. exporters will benefit, although not necessarily in the form of increased access to China's domestic markets. The more likely scenario is that American products will do a slightly better job of competing against Chinese goods elsewhere in the world. (So, of course, will products made in the European Union and other countries.)

U.S. importers will be less happy. A cheaper yuan relative to the dollar "means increased costs for companies importing from China, plus rising prices for consumers," says Josh Green, chief executive officer of Panjiva, a specialist in procurement and strategic sourcing. Let's be realistic: there are massive amounts of product flowing into the U.S. from China, and higher costs in that area will have a much greater impact on the American economy than a marginally better edge for U.S. exports in world markets. That $39.7bn U.S. trade deficit for February 2010 tells the story about where the action in this economy really is.

Green says American interests are getting steamed up about the wrong thing. What they should be fighting for is access to China's own markets through fairer trading policies, and the way to do that isn't by squabbling over the yuan. "Currency," he says, "is a little bit of a sideshow." In fact, putting pressure on China in that area could lead to trade disputes that limit access even more. That's essentially the argument made by the Retail Industry Leaders Association, which recently issued a statement supporting international efforts "to encourage broader financial sector reforms that will enable China to accelerate its removal of capital controls and allow market forces to fully determine the value of its currency."

Green has some practical advice for U.S. companies looking to minimize the impact of the yuan's inevitable re-valuation. One crucial step "is to really dig in and understand as much as you can about the health of your Chinese suppliers." Be aware of how those contracts are structured, and how they might be threatened by currency shifts. A lot of suppliers are going to get hurt by the change, he says. Are they yours?

Step two is to lock in prices in dollars to the greatest extent possible. But don't go overboard; Chinese suppliers know that currency changes are coming and might resist attempts by their U.S. customers to place them at increased risk. Call this one a delicate balancing act.

Finally, U.S. manufacturers need to think about diversifying their sourcing, if they haven't already. Many companies are becoming deeply concerned about rising labor costs in China, as well as the risks that come with longer supply lines. They're looking to relocate at least a portion of their offshore manufacturing, perhaps to Mexico or elsewhere in Latin America. (Some are even talking about producing in the U.S., but don't get too excited about that trend. A big migration of manufacturing back to American soil is highly unlikely, to say the least.)

Even with a cheaper yuan, China will remain an attractive place for offshore production for years to come. But nothing lasts forever - despite all those experts who never seem to see the bubble forming - and companies need to give serious thought to their alternatives. For those who stopped thinking strategically when the recession hit, it's time to get out of survival mode. "There's no shame in that," says Green, "but now that we're starting to see movement in China's policies, you're really setting yourselves up for trouble if you don't address it."

- Robert J. Bowman, SupplyChainBrain

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Oh, for a world of easy answers. We'd all like to see China boost the value of its currency because that would help U.S. exports, right? Well, yes - but what about all those unintended consequences?

Start with the fact that China won't do anything just because the U.S. tells it to. Who's holding most of the cards in this relationship, anyway? China has been financing our budget deficit for years now, and has stockpiled huge reserves of dollars. Moreover, it's the favorite place for American manufacturers in search of cheap labor, at least for now. So why should China take steps that would theoretically bolster markets for U.S. goods while making its own products less competitive?

Few would disagree that China has been artificially manipulating the yuan to keep it weak against the dollar. Granted, it let the currency appreciate by around 21 percent over a three-year period, but it has kept the yuan in the neighborhood of more than 6.8 to the dollar since July 2008. U.S. legislators have threatened to take punitive action, in the form of a bill that would allow for the imposition of duties in response to the yuan's continued under-valuation. The Obama Administration, especially Treasury Secretary Timothy Geithner, has spoken out on the issue, although in less combative terms. (It's more apt to make the argument that an abnormally weak yuan hurts other emerging market economies even more than it does the U.S.) And the International Monetary Fund recently urged China to let the yuan appreciate, to cool an expected growth rate of 10 percent this year.

With rampant growth comes inflation, and that's the reason why China will finally relax its grip on the yuan just a bit. The nation has done a fairly good job of controlling inflation during its dizzying expansion of recent years (again, let's give a big thanks to our U.S. manufacturers for that windfall), but it's looking at a rate of better than 5 percent by year's end, according to some experts.

The prospect of higher inflation will put China's central bank at loggerheads with the ministries in charge of promoting exports. The former is likely to prevail to at least some degree, without any help from the outside world. So doesn't that solve the problem, from the standpoint of U.S. interests?

It depends on who those interests are. Certainly, U.S. exporters will benefit, although not necessarily in the form of increased access to China's domestic markets. The more likely scenario is that American products will do a slightly better job of competing against Chinese goods elsewhere in the world. (So, of course, will products made in the European Union and other countries.)

U.S. importers will be less happy. A cheaper yuan relative to the dollar "means increased costs for companies importing from China, plus rising prices for consumers," says Josh Green, chief executive officer of Panjiva, a specialist in procurement and strategic sourcing. Let's be realistic: there are massive amounts of product flowing into the U.S. from China, and higher costs in that area will have a much greater impact on the American economy than a marginally better edge for U.S. exports in world markets. That $39.7bn U.S. trade deficit for February 2010 tells the story about where the action in this economy really is.

Green says American interests are getting steamed up about the wrong thing. What they should be fighting for is access to China's own markets through fairer trading policies, and the way to do that isn't by squabbling over the yuan. "Currency," he says, "is a little bit of a sideshow." In fact, putting pressure on China in that area could lead to trade disputes that limit access even more. That's essentially the argument made by the Retail Industry Leaders Association, which recently issued a statement supporting international efforts "to encourage broader financial sector reforms that will enable China to accelerate its removal of capital controls and allow market forces to fully determine the value of its currency."

Green has some practical advice for U.S. companies looking to minimize the impact of the yuan's inevitable re-valuation. One crucial step "is to really dig in and understand as much as you can about the health of your Chinese suppliers." Be aware of how those contracts are structured, and how they might be threatened by currency shifts. A lot of suppliers are going to get hurt by the change, he says. Are they yours?

Step two is to lock in prices in dollars to the greatest extent possible. But don't go overboard; Chinese suppliers know that currency changes are coming and might resist attempts by their U.S. customers to place them at increased risk. Call this one a delicate balancing act.

Finally, U.S. manufacturers need to think about diversifying their sourcing, if they haven't already. Many companies are becoming deeply concerned about rising labor costs in China, as well as the risks that come with longer supply lines. They're looking to relocate at least a portion of their offshore manufacturing, perhaps to Mexico or elsewhere in Latin America. (Some are even talking about producing in the U.S., but don't get too excited about that trend. A big migration of manufacturing back to American soil is highly unlikely, to say the least.)

Even with a cheaper yuan, China will remain an attractive place for offshore production for years to come. But nothing lasts forever - despite all those experts who never seem to see the bubble forming - and companies need to give serious thought to their alternatives. For those who stopped thinking strategically when the recession hit, it's time to get out of survival mode. "There's no shame in that," says Green, "but now that we're starting to see movement in China's policies, you're really setting yourselves up for trouble if you don't address it."

- Robert J. Bowman, SupplyChainBrain

Comment on This Article