This Whole Currency Thing

by BILL WADDELL

China's currency is on the move again - bad for them, we'll see how it is for the rest of the world.  It is turning out that China just has a whole lot of bad karma working against them.  The question is whether western manufacturing is smart enough to move in for the kill.

For those who aren't on top of the whole currency manipulation thing, it works something like this:  Chinese companies sell things to American companies, who pay them in dollars.  Problem is the Chinese companies need to pay their employees and suppliers in yuan.  In a normal world, the Chinese bank who takes in the US dollars would go out into the open market and trade the dollars for yuan at whatever the current exchange rate is.  Like anything else, if there are plenty of yuan out there on the market, the bank can get lots of yuan for a few dollars, and vice versa - you have to pay more for yuan if they are scarce.

As a result, if the Chinese factory needs to get 100 yuan for their product when they sell it to Walmart to make a profit, when the exchange rate is 8 yuan to the dollar (like it was a few years ago), Walmart has to pay him $12.50 (100/8).  But since yuan are scarce, the bank can now only buy about 6.5 yuans for each dollar; so to get his 100 yuan, Walmart has to pay $15.38 (100/6.5).

The way the whole thing works (or is supposed to anyway), is that everyone's imports and exports will sooner or later balance out.  Since China has built their whole strategy around exporting manufacturing, and they don't import nearly enough to offset the exports and get lots of yuan out there, they always have a lot more dollars to sell than there are yuan out there to buy.  As a result, the yuan should be getting stronger and stronger as they have to pay more and more dollars to buy the few of them on the market.  That 8 yuan a few years ago should actually be closer to 4 now, and the China prices should have doubled by now.

Only China has not been playing by the rules.  They have been 'manipulating their currency' - that is to say they have not been selling the US dollars they take in for yuan.  Instead, the Chinese government buys them from the bank at a fixed price - no matter what the price is on the open market.  What, you might ask, do they do with all of those US dollars that they can't spend in China, since only yuan are good there?  And where do they get all the yuan to pay for the dollars they buy?

Good questions - I'm glad you asked.  They have been buying lots of US government securities - T-Bills and the like, and they have been investing in stocks and bonds in American companies.  In short, lending the dollars back to us.  Eventually those loans will be paid back and China will be back to holding a lot of dollars, but they plan to worry about that when the time comes.

As to where they get the yuan, they print them up.  Hence, an inflation problem in China.If you look at this chart, you can see that China was slowly dropping the yuan, letting prices to the US increase very gradually, as they tried to keep inflation under control.  It was bad in China before the recession, but not so bad the townsfolk were storming the gates with torches and pitchforks.  Then the recession hit, however, and they had a huge problem.  While inflation would send the populace into a tizzy, unemployment would be even tougher to bear.  So they quit releasing any of the dollars and slammed a halt to any prices increases on Chinese goods.  It kept most of the factories going, but inflation kicked back in in a big way ... big enough to cause food to consume about a third of the average working stiff's paycheck.

So strikes and a lot of unrest started up - including most recently the truck drivers who haul stuff to the port at Shanghai.  The Chinese government is not overly sympathetic about such things, but they can watch the news from Egypt, Libya and Syria as well as the next guy, so they went back to putting the yuan on the move in order to slow down inflation.  Of course, that means China prices are going up again.

In the midst of it all, as if the export prices versus inflation dilemma wern't bad enough, oil went through the roof, and the cost to ship a container from China to the US of A went from about $5K to close to $8K - more price increases for Chinese goods.

This was all easy enough to see coming.  I wrote to my clients about 9 months ago telling them that China prices would be 15-20% higher in a year.  So far most of them are seeing about 12%, but my year isn't up yet.

The big retailers in the developed countries who are into China up to their necks are trying to pass the China price increases on to the consumers, whining about inflation (only it is not American inflation that is causing the problem, it is Chinese inflation).  The next moves are on the part of the western manufacturers.  They can move in for the kill by aggressively taking back the US market, or they can sit back and gripe about how hard life is in the age of globalization and how Obama just doesn't understand and let China survive all of this.

Comments

[Martin_B]

"the yuan should be getting weaker and weaker"

I think you mean "stronger and stronger."

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Thanks for catching at and straightening me out Martin. I corrected the mistake.

[Aaron]

Except, its not just the Chinese Govt printing off money now, is it? How much has the American Govt printed?

[John Buzolic]

Australia has one more problem to add to this mess. Our dollar is going up faster than light, keeping the Chinese imports cheap and protecting their markets from Australian manufacturers. Our miners can make a killing from high commodity prices but the rest of the country can no longer export or gain any advantage in local markets. There is a recession on here but nobody is taking any notice.

[Gray Rinehart]

Very interesting post, Bill, thanks!

[Mike]

If the Chinese printing yuan is an effort to maintain the yuan:dollar ratio, is a side effect of the printing of dollars by our government to stabilize our economy countering the Chinese effort?

[Paul Todd]

I'm dismayed when I see in the comments that the US is "printing money" in the same way China is. When the Federal government needs more than it gets in taxes, it borrows money by selling bonds, to China in this case. This is not fake or free money - it is a loan just like you or I would get, and must be paid back with interest. The Chinese inflation problem and the financing of giant US budget deficits are different problems, albeit intertwined.

[Bill Waddell]

Paul,

I assume he was referring to the Quantitative Easement initiatives which were, in fact, little more than printing money. You are right, though, it is quite a stretch to compare the US with China in this regard. Quantitative Easements to stave off deflation - while I don't agree with the idea - are nothing like what China is doing to try to 'buy' the world's manufaturing base.