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China Unties Currency From American Dollar; U.S. Is Hopeful, but Industry is Wary

Posted on: Friday, 22 July 2005, 15:00 CDT

China on Thursday announced its biggest trade concession with the United States in years, uncoupling its decade-old fixed exchange rate with the dollar and switching to a looser system that should work over time to the advantage of U.S. exports into China.

In Washington, which has pressured Beijing to abandon its cheap exchange-rate policy, the announcement instilled hopes that the move would ease U.S.-China trade frictions, which have escalated with recent Chinese takeover bids for U.S. companies.

"We're very pleased with this action on the part of the Chinese," Treasury Secretary John Snow said.

But the move generated skepticism in the American industrial heartland, where competition with inexpensive Chinese imports has decimated employment and put scores of manufacturers out of business.

Johnson Controls Inc. dismissed the move as "more symbolic than anything else," in the words of Steve Roell, vice chairman of the multinational firm, which is Wisconsin's largest corporation by sales.

"What was announced today was so minimal," Roell said, a remark echoed in the Midwest. He spoke during a conference call to discuss the company's quarterly earnings.

Exchange rates hardly rank as the main reason that China has siphoned so many jobs from Western nations a trend that most economists attributed to China's inexpensive labor, as well as its embrace of cutting-edge automation and its proliferation of engineering schools. But currency rates are the single area in which politicians have any hope of forcing change in the wildly lopsided trade relationship.

For the past two years, Washington has labeled China's trade practices unfair, in part because it has argued that the Chinese Central Bank has kept the yuan's value artificially low, which in turn makes Chinese goods even cheaper to sell abroad.

The central bank, in a carefully worded statement, said it would abandon the rigid exchange-rate peg that it has kept against the dollar since the mid-'90s. The People's Bank of China, which froze the dollar for years at 8.28 yuan, let it fall Thursday by 2.1% to a rate of 8.11 yuan.

The central bank also opened the door for a further appreciation of the yuan, moving as much as 0.3% each day. But the bank's statement was vague and left currency markets speculating about how rapidly China would allow its currency to rise.

Snow to watch Beijing

Economists widely believe that the dollar would have to fall 10% to 40% against the yuan before American companies would feel any meaningful trade relief.

"While the initial 2.1 percent revaluation is inadequate, we view it as the beginning of what should be a significant revaluation," John Engler, president of the National Association of Manufacturers, said in a statement. "China's new currency system offers the possibility for continued upward movement of the yuan in the coming weeks and months, and that is what we will be looking for."

Snow vowed to monitor China's progress in loosening its currency controls.

Currencies have been at the heart of a far broader political firestorm.

At issue is America's inability to produce as much as it spends. As a result, the United States imports heavily cars, clothing, mobile phones, golf clubs.

The U.S. now presides over the biggest merchandise trade deficit in history. Its $170 billion yearly trade deficit with China ranks as the biggest between any two nations. The tidal wave of cheap made- in-China goods into American stores has risen to records each year, and some Midwestern manufacturers cannot compete with low Chinese costs.

China, in the meantime, has emerged as a world-class economic power. Its economy grows 9% each year, it's rich enough to make daily loans to the U.S. government, and it boasts more Internet users than the U.S.

"This is a gradual appreciation of the yuan," said Mary Regel, an adviser to Gov. Jim Doyle on international trade. "It'll take quite a while for that to be effective."

Under the outcome that Regel envisioned, China's stronger currency would allow the Chinese to buy more U.S. goods. "It will make U.S. goods slightly more affordable," she said.

James Buchen, the vice president and chief lobbyist for Wisconsin Manufacturers & Commerce, an industrial trade group that represents 4,000 companies, said: "Time will tell whether they are serious about this or not. We'll see how it evolves."

For show'?

Michael Retzer, an executive at W.G. Strohwig Tool & Die Inc. in Richfield, has been one of the state's loudest critics of U.S. trade policies with China. But Retzer said the latest development might be neutral at best in its impact for the U.S.

"For the last couple years, I've maintained that their loosening of their peg would hurt us more than it would help us," Retzer said.

He cited statistics that show China's export-driven economy relies heavily on imports of raw commodities, semiconductors and energy from the rest of Asia. A stronger Chinese currency would allow Chinese manufacturers to buy their raw material imports more cheaply than before and pass the savings on to the consumer.

That means that made-in-China goods become cheaper even before they leave Chinese shipping ports for the U.S., and it preserves at least some of their price advantage even as the dollar falls, Retzer and economists argued.

"For all the wrong reasons, our exports are not going to be any more competitive," Retzer said. "This little thing is for show."

Charles W. McMillion, president and chief economist of MBG Information Services, a Washington forecaster, concurred that China will gain advantages from cheaper raw material imports. He also said that exchange rates aren't the central trade issue with China. But he welcomed the move.

"It's a responsible step, and I hope that they continue to allow and even to push the yuan for several months," he said.

Analysts said the Chinese Central Bank made the move to ease trade frictions, which have hit extremes in recent weeks.

China's CNOOC state-run oil company last month made an $18.5 billion bid to acquire Unocal Corp., a U.S. oil company. That followed the $1.3 million offer by Haier, a major Chinese appliance- maker, to buy Maytag Corp., the iconic but struggling U.S. rival.

Much of the U.S.-China trade friction originates with China's disproportionately cheap labor. Pay levels are so low in China that labor costs represent only a small part of the nation's production costs. Unskilled labor, converted into dollar terms, can be as cheap as 25 cents an hour. Trained Chinese workers, meanwhile, often receive little more than a dollar an hour.

Even a sharp 20% jump in the value of the yuan and a commensurate 20% rise in Chinese labor costs after those costs are translated into dollars would serve to increase the skilled worker's pay to only $1.20. Even after a major fall in the dollar, that remains a fraction of any American take-home pay, skilled or unskilled.Albert Cervero, senior vice president of the Association of Equipment Manufacturers, a national industrial trade group in Milwaukee, said Chinese labor costs are only one aspect of a broader set of cost issues that exchange rates cannot address.

Other factors

"We have unbelievable litigation in America that does not exist in China," he said, citing one factor that drives American costs higher and prompts American manufacturers to move jobs abroad. "Look at any company, Ford, GM, Caterpillar. They have unreasonable liability costs, and it's not because of their products."

Chinese companies also operate without paying the health care costs and meeting the environmental regulations expected in Western economies, he said.

A weaker dollar can even complicate the U.S.-China trade relationship.

To consume more than it produces, America has to borrow. Because Americans have a national savings rate near zero, they borrow from abroad. And China, lush with dollars from the goods it sells to America, has become the second-biggest lender to America, behind Japan.

China accumulated huge reserves of dollars and used them to buy $750 billion in Treasury notes. Its daily purchases of Treasury debt, in effect, give America funds it needs to pay its own bills.

Tim Sheehy, president of the Metropolitan Milwaukee Association of Commerce, called the announcement Thursday a "double-edged sword."

The exchange-rate adjustment can help lower the cost of U.S. imports into China, he noted. But a weaker dollar undermines the dollar's role as the leading global reserve currency held by other central banks.

Sheehy said the dollar's decline might make China less interested in holding dollars and bailing out American debt.

"We're past the point where you can swing a sword at China and not have the impact felt in the U.S.," Sheehy said.

Thomas Content of the Journal Sentinel staff and Bloomberg News contributed to this report.

Copyright 2005, Journal Sentinel Inc. All rights reserved. (Note: This notice does not apply to those news items already copyrighted and received through wire services or other media.)

Source: Milwaukee Journal Sentinel

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