Much ado about nothing

September 15, 2010
By: Eric Lundin

China’s currency is in the news again. It made big news back in the summer of 2005 when the Chinese government unlocked the currency from the fixed exchange rate of 8.2765 yuan per dollar. Change came slowly; a year later it had appreciated just 3 percent, to 7.6055 yuan per dollar. The rate of change picked up for a couple of years, then apparently the Chinese government put on the brakes again:

  • July 2007:  7.6055 per dollar (5% change in 12 months)

  • July 2008:  6.8608 per dollar (10%)

  • July 2009:   6.83307 (0.4%)

  • July 2010:  6.78099 (0.8%)

On Monday, Sept. 13, it was 6.76182 per dollar, and it appeared that China was letting it appreciate steadily for a few days on the brink of two days of Congressional hearings on China's policy of currency manipulation.

Many say that China’s currency is undervalued, making Chinese prices artificially low, and the currency should appreciate more, thereby leveling the international playing field. Another route is to retaliate against China through tariffs or other trade barriers.

This seems to be a bad time to throw a third wrench into the works. Third wrench, you ask? Yes, third wrench. Late last week I had a conversation with a fabricator and OEM—one who wishes to remain anonymous, by the way—about the intermediate goods it purchases from a vendor in China. The cost for the material it purchases has risen by 20 percent in just a few months. The two main culprits driving the prices of Chinese goods higher are wage increases and energy rationing.

Higher pay has been a topic for months. Labor strikes in China in May led to pay increases from some employers in early June, followed by minimum wage increases in July in some localities. 

In a separate development, local governments throughout China have been rationing power recently for two reasons: to reduce the country’s power consumption and to cut emissions.

It doesn’t take an accountant to understand that the first wrench, higher wages, leads to higher prices. And it doesn’t take an economist to understand that restricting the supply of a good or service leads to a bidding war, which also pushes up prices.

Enough with the detail. Let’s take a step back and look at the issue from a broader perspective. The U.S. economy is the largest in the world; our GDP, the measure of final goods and services, is estimated to be $14.8 trillion. China’s is in the No. 2 position at $5.4 trillion. As far as trade goes, the U.S. and China are tightly intertwined. Companies in the U.S. imported $194 billion in goods from Chinese companies in the first seven months of 2010; trade going the other direction amounted to $49 billion, January to July. Regarding imports, China is our biggest trading partner; for exports, China is our third-largest trading partner (behind Canada and Mexico).

I doubt much will come from the congressional hearings. Like it or not, the two economies are closely linked and even small changes can have big repercussions. Chinese prices are cruising upward for domestic reasons, and political pressures from the U.S. to force a change in the exchange rate would put unwelcome stresses on both economies.
Eric Lundin

Eric Lundin

FMA Communications Inc.
2135 Point Blvd
Elgin, IL 60123
Phone: 815-227-8262