Chinese Balancing Act

On July 21, the Chinese government rocked financial markets when it announced it was revaluing the yuan from 8.28 yuan per dollar to 8.11 yuan per dollar, a 2.1 percent appreciation.

In addition, the government said that instead of pegging the yuan against the dollar alone, it will trade its currency against a “basket” of currencies, which, in theory, will allow it to either strengthen or weaken against the dollar. That basket of currencies was identified by the Central Bank of China on Aug. 10 to be the U.S. dollar, the euro, the Japanese yen, and the won of the Republic of Korea.

The U.S. government has been arguing that the yuan (or renminbi, which means “the people’s currency”) is undervalued. Many government officials and manufacturers in the United States have been pushing for the Chinese government to provide more flexibility in the currency by “floating” it so it can find its real exchange value in relationship to other currencies. It is believed that if allowed to float freely in the marketplace, the yuan would be substantially stronger against the dollar, making China’s exports relatively more expensive. In turn, U.S. consumers would be less likely to buy Chinese products, and U.S. manufacturers would be more likely to sell their own products, not only to U.S. consumers, but also to the burgeoning Chinese market.

That scenario would improve the U.S. trade deficit with China, which stood at $162 billion in 2004, an increase of 30.6 percent over 2003 figures and a whopping 540 percent over the 1995 figure of $30 billion. Jewelry accounted for $1.6 billion of the 2004 total, according to Manufacturing Jewelers and Suppliers of America. The U.S. trade deficit with China is larger than its deficit with all of Europe and larger than its deficit with Canada and Mexico combined.

A SYMBOLIC CHANGE

Chinese revaluation, according to economists and others interviewed for this story, will have a negligible impact on trade with the United States. Nevertheless, it’s considered a hopeful sign that manufacturers, including jewelry manufacturers, will have a better chance to compete with those who have manufacturing facilities in China.

“It’s really much more of a symbolic change than a substantial or material change,” says Carl Steidtmann, Deloitte Research chief economist and a nationally recognized expert on economic forecasting of retail sales activity, consumer trends, technology, and general economic trends. “The important thing is that China has taken the first step to increasing the yuan. The jewelry industry is one that will be significantly affected both on the production side, by making manufacturing of jewelry goods in China a little more expensive to consumers, and particularly on the demand side, because the increase in the value of the currency increases purchasing power. Think of a currency as reflective of the purchasing power of a country. When the purchasing power of the yuan goes up, it reduces the price of gold and jewelry to consumers.”

The value of the Chinese yuan has been one of MJSA’s key legislative concerns. James F. Marquart, MJSA president and CEO, says China’s move to revalue its currency is a good first step, but much more has to be done.

“I don’t think it’s going to have a major impact right away,” Marquart says. “It does set in the mind of our legislators that the Chinese government has done something to address the issue, although it’s nowhere near enough.”

Marquart notes that while the price of the yuan “could have some impact” on trade, there are other imbalances between the two countries in terms of how business is conducted. “The cost of labor is so much cheaper, and they don’t have the environmental issues we have in the United States,” he says. “So much of the retail community buys on price. We also have to look at those aspects of the cost structure.”

Marquart also notes some disadvantages to relying on cheap-labor sources: “How quickly can [they] respond to an order? There are technology issues.”

A SIGNIFICANT STEP

Scott Hoyt, director of consumer economics at Economy.com, which provides economic, financial, country, and industry research, says the 2.1 percent appreciation will easily be absorbed in the supply chain. He says the more important point is that the Chinese are willing to create a new monetary policy.

“Two percent is inconsequential,” Hoyt says. “It’s not the size of the move but the expectation of putting the mechanism in place to make additional moves.”

For example, Hoyt says Wal-Mart imported $18 billion worth of goods from China in 2004. “While that may seem big, it’s only 8 percent of the total cost of goods [Wal-Mart purchased for the year]. Even if you assume with the removal of quotas that it amounts to 10 percent in merchandise, a 2 percent increase in costs for 10 percent of merchandise is a 0.2 percent increase in merchandise costs. It’s not a big deal.… Space that output over 10 months or a year.… As a consumer, are you going to notice that?”

Hoyt adds, “And it’s not going to happen all at once, because contracts have fixed prices.… The other argument is that Chinese manufacturers may bear some of the brunt of this, so it gets even smaller.”

Jason Schenker, a Wachovia bank economist, agrees. He notes that import prices have risen by about 7 percent during the past year. “I don’t think this 2.1 percent is significant enough in and of itself,” he says. “It could be passed on or absorbed by the companies.… Relatively speaking, it’s not going to be all that big a deal.”

Still, if the yuan continues to rise against the dollar, it could help U.S. jewelry manufacturers compete with low-cost Chinese goods.

THE NEXT MOVE

Economists have speculated that the Chinese government may allow the yuan to gradually increase, but the first month after revaluation saw the currency rise—and fall—slightly.

Steidtmann says most economists think a 20 percent to 40 percent increase is needed to create parity with the U.S. dollar. “We have a long way to go,” he says. Schenker’s view is that even if the yuan is allowed to increase gradually, the appreciation won’t exceed 10 percent. “But we’re likely to see far less than that,” he adds.

Marquart would like to see the Chinese currency free float like the U.S. currency so it would trade at fair market value. He also understands that that’s wishful thinking. “Their intent certainly appears to be that there’s not going to be more than a 1, 2, 3 percent revaluation. It’s not anywhere near what we would like to see happen. A 1 or 2 percent change is not going to have a big impact.”

Steidtmann says that as China continues to move from a communist-based economy to a capitalist one, it will have to make countless internal changes before it can even consider a free float of its currency. “A free float is probably where they are headed, but that’s a long way off,” he says. “I don’t think it is quite ready for that politically and socially.”