A Revalued Yuan: Will It Improve the United States Trade Balance?

Yesterday morning, news reports were filled with headlines that President Barack Obama had “vowed to get tough” with China on its currency. By the end of the day, the headlines told how China was “hitting back” over Obama’s criticism of its currency policy. And so it goes. A currency dispute between the two superpowers now joins tariffs, climate change, Google and the Internet, arms sales to Taiwan, Iran, and the Dalai Lama on the list of issues where the two countries don’t see eye to eye.

But, will a revaluation of the yuan against the dollar really lower China’s exports to the United States and have the impact on the U.S. negative trade balance with China that President Obama thinks? Some experts aren’t so sure. Before President Obama issued his statements and created this latest row with China, he should have read “The China Export Edge”, an excellent editorial by Alexandra Harney that appeared in Wednesday’s Wall Street Journal.

Alexandra knows a good deal about this subject. In 2008, she authored the bestselling book, The China Price, and is currently a visiting scholar at the Center of Asian Studies at the University of Hong Kong. I have had the pleasure of appearing on several panels with Alexandra and trading ideas on a variety of topics over the last several years, and there’s no question that she knows her stuff. Unlike many who write on these subjects, her opinions are based on real, on-the-ground research, not just theory.

In her article, Alexandra gets right to the point:

Anyone pinning their hopes on a rapid revival in American manufacturing as a result of a revaluation of China’s currency needs to meet Ben, the owner of a coastal Chinese shoe factory.

Conventional wisdom holds that exporters in China like Ben, a Chinese man who asked that his surname be withheld to protect his competitive advantage, should have been devastated by the Great Recession of 2008-09. China’s export volume shrank 16% in 2009, and some 23 million migrant workers lost their jobs in the downturn.

But last year was Ben’s best ever. As his competitors teetered, Ben invested $2 million in new equipment to shift away from making cheap, no-brand shoes and into steel-toe work boots, hiking shoes and branded athletic footwear. He now produces these under contract for well-known Western companies. Ben’s average selling price has almost tripled. Sales are up more than 50% year-on-year.

In other words, China’s manufacturing is now moving up the value-added chain, and is becoming even more globally competitive as a result. In doing so, to quote Alexandra:

China has turned the Great Recession into the Great Opportunity, growing its share of imports in the United States to 19.1% from 15.9% between November 2008 and November 2009. That share is only going to increase, regardless of what Beijing does with the yuan. After years of accumulating market share and building the infrastructure to supply the global market with the help of an undervalued currency, China’s advantage is so entrenched in certain industries that a yuan revaluation is unlikely to divert substantial volumes of orders to other countries.

While the years of profligate American consumer spending were boom times for Chinese exporters, the slowdown was like a one-year MBA program: It forced surviving exporters to focus on the bottom line, invest more in research, development and product design, and find new markets for their products. “We need to reduce labor intensity and improve productivity, or else we’ll lose orders to our competitors,” says Ben, who counts some 6,000 rivals in his city alone.

I’m with Alexandra on this one. Her analysis and real-life example help explain two statistics that I like to quote when speaking on this subject.

In the 1980s, Japan was in exactly the same place as China. The country was exporting more and more to the United States, and its currency policy was under attack. Giving in to pressure from the United States, Japan’s currency was revalued. In 1985, one U.S. dollar bought 250 yen. By 1988, one buck could only purchase 121 yen. What did Japan’s exports to the United States do during this period? They increased from $69 billion to $90 billion.

The same thing happened with China. From mid-2005 to mid-2008, the yuan appreciated by approximately 20 percent. What did China’s exports to the United States do during this period? They increased by 40 percent from $163 billion to $233 billion.

In the case of both Japan and China, exports to the United States did not decline when their currencies appreciated against the greenback. Instead, manufacturers in both countries started getting paid more for what they sold, and they began producing higher value-added products.

Instead of listening to the theories expounded by his well-educated staff of economic advisers, or the union officials and other interest groups that want to blame China for all of America’s ills when he wants advice on currency policy, President Obama should take Alexandra’s parting advice. He should “Just ask Ben.”

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