China's Yuan Will Appreciate Soon

On April 15^th the U.S. Treasury Department, in consultation with the International Monetary Fund, will issue its semiannual report on the exchange rate policies of foreign countries.  Many, including over 130 of our elected officials, are encouraging the designation of China as a “currency manipulator”.  If so, the U.S. could immediately impose a surcharge on goods imported from China

Beginning in 2008, after three years of the yuan appreciating some 21% against the dollar, Beijing fixed the exchange rate at 6.83 yuan to $1.  They have maintained this rate ever since.   Dan DiMicco, president, chairman, and CEO of Nucor Steel along with Peter Navarro, a professor at the Merage School of Business, University of California at Irvine discuss China’s fixed exchange rate in a Barron’s essay saying, “China’s undervalued yuan provides a subsidy for Chinese exporters, while effectively levying a tax on U.S. exports to China.  This currency manipulation, combined with Chin’s export subsidies, has resulted in chronic U.S. trade deficits, a weakening of our manufacturing base and the loss of millions of American jobs – as China has boomed”.

These same thoughts are held by Paul Krugman, Nobel Laureate who is calling for war.  In his March 15^th New York Times Op-Ed Column titled “Taking On China”, he called for a new trade war with these words, “In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10% surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies.  At this point, it’s hard to see China changing its policies unless faced with the threat of similar action – except that this time the surcharge would have to me much larger, say 25 percent”

Of course, provoked by our Senators, Mr. Krugman, Mr. DiMicco and others, Chinese Premier Wen Jiabao said to reporters on March 14, “We oppose mutual accusations between countries, and even using coercion to force a country to raise its exchange rate, because that’s of no help to reforming the yuan exchange rate.  We don’t believe the yuan is undervalued.”  In addition, he stated “I can understand some countries’ desire to raise exports, but what I do not understand is depreciating one’s own currency and attempting to pressure others to appreciate, for the purpose of increasing exports.  In my view, that is protectionism.”

I may have a few years on me, but I can still remember the testosterone wars of my youth, when the goal was to walk away with your dignity, not a black eye.   These youthful wars of words must have been practiced by our leaders in America as well as those in China.  Each in their own right is attempting to maintain some dignity and solve a common problem with words.  This is a far better solution than going to war.  Mr. Jiabao is fully aware of the problems his currency is causing his own country.  China’s undervalued currency has lead to uncontrollable money growth, which in turn has overheated the Chinese economy, increased real-estate prices to levels that could be problematic and created an unsustainable inflation rate.   

China’s political leaders have a history of dealing with overheated growth rates by throwing punches, not at foreign governments, but at their citizens.  In 2003 and 2005, faced with rapid growth, China chose to shutdown their credit markets.  My thoughts are that China will handle the current overvaluation problem in a similar way.  Without warning the yuan will be allowed to float, albeit not freely, but at a controlled rate.  This will happen, not as a result of the threats thrown out by 130 of our elected representatives, the likes of Paul Krugman, or our CEO’s, but because their own economy will benefit.    Without it, a trade war is possible and would ultimately punish all of us.

Kendall J. Anderson, CFA