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China Dumps U.S. Dollar
by John M. Curtis
(310) 204-8700
Copyright July 22, 2005
All Rights Reserved.
 hrowing currency traders for a loop, Beijing severed its 11-year tie to the U.S. dollar, floating the yuan, raising its value 2.1%. Under mounting international pressure, China ends its link to the dollar, something that gave its currency stability, while its economy moved from the oxcart to space ships. For years, China resisted the idea of floating its currency, preferring current exchange rates keeping its goods competitive in world markets. Floating the yuan risks the kind of competitive bidding that could price China out of the global economy. While China's growth rate at 9.5% remains torrid, escalating the yuan's value could throw ice water on economic growth. With the U.S. dependent on Chinese manufacturing, raising the yuan could fuel inflation in a wide range of consumer goods. Favorable exchange rates have made China the world's most attractive manufacturing base.
U.S. policy makers hope that detaching the yuan from the dollar would reduce the U.S. trade deficit, soaring to an unprecedented $161 billion. Yet the more costly the yuan, the more likely U.S. companies would go further into the third world, including less developed parts of Asia and Africa. Speculators and currency traders could trigger a buying frenzy, driving the yuan to new heights. For years, foreign governments pushed Beijing to float its currency opening more competitive import markets. American companies hope that cheaper exchange rates—at least for China—will stimulate purchases of such staples as U.S. copper, cotton and soybeans. U.S. lawmakers, including Federal Reserve Chairman Alan Greenspan, applauded China's move, hoping that new currency rates would boost U.S. exports. European finance ministers also praised the move.
By moving away from the dollar, foreign governments were hoping to siphon off China's historically heavy investment in U.S. treasuries. Floating the yuan could discourage China's investment in U.S. treasuries, forcing Greenspan to continue hiking interest rates. With many U.S. companies dependent on Chinese manufacturing, a rising yuan means higher manufacturing costs. Added to that rising fossil fuel costs, the prices of landed goods, including transportation costs, could fuel more inflation, pushing Greenspan to further rates hikes. "Today's developments are extremely positive,” said U.S. Treasury Secretary John W. Snow, who, in a recent trip to Beijing, pushed officials to revalue its currency. Snow and other free traders inside the White House don't see the bigger picture of how floating the yuan could increase Chinese manufacturing costs, fuel inflation and put a drag on the U.S. economy.
China's economy has been steaming along, reporting a sizzling 9.5% growth rate. Foreign currency traders have argued for some time that the yuan was undervalued by some 40%. If market forces take hold and the yuan gains more value, a wide range of U.S. companies could get hurt. “Given how heated the atmosphere has become with the last few months, this will be seen as a responsible act good for China and good for the international financial system,” said University of Chicago China expert Dali Yang, voicing the conventional wisdom that a more competitive yuan will spread the wealth to other countries. Foreign manufacturing, while helping China's Gross Domestic Product, doesn't give Beijing the lion's share of profits. China benefits by reducing unemployment and collecting more taxes, but doesn't retain foreign corporate profits into its the economy.
Until China becomes a global branded leader in technology and consumer goods, it's unlikely that it will compete with established U.S. and European companies. China's growing manufacturing base and consumer economy has augmented its needs for fossil fuels, already driving up global petroleum prices. “We don't expect a 40% revaluation overnight, but we reject token steps and political manipulation at the whim of the Chinese government,” said Kevin Kearns, president of the U.S. Business and Industry Council, a trade group that represents small and medium size businesses. Kearns responded to China's cautious increase in the yuan from 8.28 to 8.11 to the U.S. dollar. Many small and medium sized U.S. and foreign companies hope to capitalize on the yuan's increased buying power. What they don't get is that large-cap companies like Wall-Mart, Target and the Gap could lose their shirts.
Floating China's currency has dangerous implications for the U.S. and world economy. With the dollar declining in value against the yuan, Greenspan will be forced to hike rates to make U.S. treasuries more attractive. It's a good thing that China's finance ministry will continue to value the yuan within a narrow band, preventing traders and speculators from bidding its currency into outer space. “For sure, people will psychologically expect more, and their belief in further yuan revaluations will become stronger,” said Ye Huide, president of the Shanghai Taiwan Investors' Assn., attesting to the government's pressure to continue hiking currency rates. Floating the yuan puts the fate of U.S. and foreign companies into the hands of Chinese government bureaucrats. With so many U.S. and foreign companies hopelessly dependent on Chinese manufacturing, it's a big risk.
About the Author
John M. Curtis writes politically neutral commentary analyzing spin in national and global news. He's editor of OnlineColumnist.com and author of Dodging The Bullet and Operation Charisma.
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