Let's Not Fight a Currency War With China

First, let's do away with the myth that some currencies float freely.

They don't. Each national government, and in the case of the euro, the European Union, has in its kitty tools for manipulating currencies, although the ability to do this can vary widely. Already, one of the threats against China in the ongoing war over the yuan-dollar-euro-yen exchange rates is the possibility of Western central bankers steadily dropping the value of their own currencies by simply printing money and using it to purchase government bonds.

As Paul Kasriel, chief economist at the Northern Trust Company, has famously noted, the US Federal Reserve, for instance, is "a legal counterfeiter" because it can print the dollars to buy government bonds -- flooding the market and potentially impacting exchange rates -- and not be held accountable for its actions; this in a capitalist system that supposedly allows the "free" market to set currency exchange levels.

China, of course, is not one of those countries that give the investment market the power to determine the value of its currency -- a choice that is now threatening global commerce as Western economies rail against the Communist government's "manipulation" of the yuan. If the rhetoric continues to heat up, fueled in the United States by Congressional elections later this month, many countries could introduce punitive measures against Chinese companies and goods. This is more than just a US-China spat, however. Government officials in the United Kingdom, Germany, and Brazil have made similar comments about the negative impact of an artificially propped up yuan on global commerce.

The US House of Representatives waded into the fray recently by passing a bill that would allow companies to seek tariff protection against any country that deliberately undervalued its currencies. It's hard to see how any company would prove such a case. China, they argued nevertheless, must be compelled to devalue its currency or face a trade war.

Here's why this is a very bad idea. The West can no more force its will on China than unhinge its wagon from Beijing's. China is today the de facto country for global production, and most of the goods exported by the nation are produced by or for Western companies headquartered in those countries that are protesting against Beijing's currency regime. Any disruption to the system, however well managed, will have global reverberations.

This does not mean, however, that those complaining of China's "inflated currency" do not have a point. By carefully setting the band within which its currency could trade, China has removed uncertainty from its own system but also created problems in other parts of the globe where floating currencies must respond largely to demand and supply issues.

There are implications here for the high-tech sector. The technology supply chain is heavily dependent on China although it is not centered in one location. Many OEMs see China as an integral part of their operations but have diversified the design, procurement and manufacturing system much more extensively than the "just-move-to-China" mentality would suggest. Today, Brazil, Mexico, and Eastern Europe are also quite important to the high-tech supply chain.

A battle over the yuan between China and Western countries will introduce uncertainties into global commerce and hurt high-tech companies. Therefore, cooler heads must prevail on both sides, and the combatants must strike a balance between the need for fairer currency practices by all countries and China's need to carefully manage its ongoing integration into the global economy.