Tag Archives: China

Chinese currency policy

The import textile quota expiration may be a catalyst for political pressure on Chinese currency policy. Non-Chinese emerging markets will threaten to devalue or peg their currencies as long as the US is not punishing that type of behavior.

See also: Renminbi Valuation

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Is Global Free Trade Always Good?

As long as trade is at will by both parties, it is good, right?

Not necessarily.

Innovation has led to great developments in goods and services, and led to amazing increases in productivity and capacity utilization. International trade is distributing value more efficiently than ever.

Peter Weiss raises an important counterpoint:

“[clip] The dislocation is often painful and some people cannot make the transition for any number of reasons – I don’t minimize or ignore their pain, or loss. As people living in a community, however we define it, we should consider how we respond to them [clip]”

Throughout history, the waves of displaced workers have ranged from negligible to crisis levels. Displaced workers are typically older workers who are highly skilled in a shrinking industry, or people of all ages who do not have economically rewarding skills. The first set of people is generally easier to define because they had and lost their jobs, while the second set may be far more difficult to quantify.

In the transition to the industrial age, displaced farmers, craftsmen, and tradespeople went through fairly desperate poverty, but there was a large industrial complex forming, ready to hire people with a wide range of skills. In the information age, and with a far larger and more anonymous society, we are dealing with new dynamics. Automation is increasingly replacing labor in production, putting a greater emphasis on capital. The economically rewarding skill set is becoming more cognitive, scalable, and competitive. The highly scaled production of the globally efficient producers displaces less efficient producers throughout the rest of the world.

Why would this be a problem? Clearly, we already acknowledge that some trade should be illegal: monopolistic mergers are restricted by the Federal Trade Commission. Even overly concentrated industries may have restrictions on further consolidation. With information services and assets, marginal costs fall to about zero, and this economy of scale is a strong force for monopolies within each product or service class. Innovation can be stifled if monopolists prevail. However, this dynamic cannot be controlled globally by the US Federal Trade Commission.

But it goes further than that: whenever productivity rises faster than production, fewer workers are required in aggregate. Production may still be growing, but the non-working population and increasing concentration of wealth means that the median utility may shrink. Recent drops in interest rates has promoted refinancing and debt, enabling continuation of consumer spending, but factoring out this externality implies a scary economic reality.

I’m afraid I can’t offer a comprehensive solution, but as policy makers (or simple commentators), the goal should be maximizing the growth rate of the median utility, right? The Fed and international trade policy are currently influenced by an optimization problem that maximizes total GDP growth. Changing the nature of the optimization has the potential to imply that free trade might not always be good. Similar to the measures put in place to avoid the downsides of monopolistic trade in the US, legal and financial policy reform may be due in the next decades to enforce rules as a Global Trade Commission, and also to target disadvantages from productivity growth overwhelming production growth.

Renminbi Valuation

The renminbi is pegged to the US Dollar, and has been for a long time, so what would a revaluation of the Chinese currency mean? Without an exchange rate determined by the marketplace, how can we anticipate the magnitude of the difference between the pegged rate and the appropriate market rate?

It is clear that the yuan is cheap relative to the dollar, but by how much? Our economies are different, and these differences lead to different relative pricing, but looking at a variety of prices can give us some sense of purchasing price parity.

Unskilled Labor:

Textile workers in China are paid about 1/30 of the amount paid for equivalent work in the United States. If this ratio were to equalize through currency revaluation, the yuan would increase by 3000%. However this is almost certainly too high, as China has an oversupply of unskilled labor. This number provides the high-end boundary on the scope of the question.

Gold:

Gold can be purchased in yuan At the time of this writing, $442 worth of gold costs 3670 yuan, implying an exchange rate of about 8.303 Yuan/$. If this ratio were reflected in the currency echange rate, the yuan would increase a negligible amount (Because the exchange rate peg is currently 8.27 Yuan/$). However this is almost certainly too low, as it is illegal for chinese citizens to invest in Gold. This number provides an low-end boundary on the scope of the question.

Basket of goods:

Depending on the basket you select, purchasing price parity implies different undervaluation of Yuan. I estimate approximately 40% undervaluation, clearly with different classes of goods and services.

Trading:

Under a fair and open market, I envision a 40% inflation on Cinese imports would greatly imporove the stature of US companies that have been drowning under Chinese import competition. Similarly, Chinese companies that earn their revenues from Chinese will see a US Dollar denominated revenue increase of 40%.

[UPDATE 1/25/2005]

Senator Lindsey Graham, (R) Judiary Committee and

Senator Charles (Chuck) Schumer, (D) Finance Committee

are announcing bill to impose a 27.5% tarif on Chinese imports, implying their view that the Renminbi is near 27.5% discounted against the Dollar.

[END UPDATE]

Let’s speculate that Chinese currency will reflect market forces within 2 years. In this speculative possible environment, investors might benefit from:

underweight Chinese companies with revenues largely based on exports

overweight Chinese companies with revenues largely based in China

underweight US companies who import from China

overweight US companies who compete with Chinese imports

Now let’s speculate that Chinese currency will remain pegged to the US Dollar. In this speculative possible environment, investors might benefit from exactly the opposite positions.

How can the US exploit a currency peg that is clearly an unfair trade practice?

Cut taxes and issue more debt.

This increases the Federal deficit, diminishing the value of the US Dollar, and also increases the after-tax pay rates for US workers.

Agricultural Commodities

Recommended reading: Mark Faber’s analysis of agricultural commodities (MP3 Audio / Transcript).

Favorite Excerpt:

Some commodities may have overshot already, but agriculture is one of my favourites because food production in China has been declining. They have a water problem, and through the industrialization and the construction of golf courses there’s less land available for agriculture.

So I would go and look at some agricultural commodity prices that haven’t moved much yet like corn, soya beans, wheat, sugar. The Swiss drink 50 times more coffee per capita than the Chinese, but the Chinese have a population 200 times larger than the Swiss so their market is already larger. If they go to the per capita consumption level of the South Koreans, Taiwanese, Japanese – non-traditional coffee drinkers –
they will take up three times the coffee crop in the world.

Electronic terrorism and anti-terrorism

The Los Angeles Times is reporting that the CIA is warning of possible cyber-terrorism against U.S. and Taiwanese computer systems by the Chinese Army. The United States Secret Service is considering proactive defense strategies.