US Gains Edge as China’s Currency Strengthens

The US Department of the Treasury has once again declined to label China a currency manipulator, and, in its latest report on international exchange rates, notes that over the past two years China’s currency, the renminbi (RMB), has gained strength against the US dollar. This news brings mixed fortunes for high-tech manufacturers.

On the one hand, a stronger Chinese currency versus the US dollar helps American companies compete more aggressively on product pricing with companies such as Lenovo, Huawei, and Haier in overseas markets. The downside, however, is that costs associated with supply chain operations located in China will only rise as the RMB strengthens in value.

Like previous reports, which evaluate international economic and foreign exchange developments, the November 27th Semi-Annual Report to Congress on International Economic and Exchange Rate Policies not only refrained from branding China a currency manipulator but also had this to say:

From June 2010, when China moved the renminbi (RMB) off its peg against the dollar, through early November 2012, the RMB has appreciated by 9.3 percent against the dollar and 12.6 percent on a real, inflation-adjusted basis. China’s trade and current account surpluses both have fallen to 2.6 percent of GDP from a peak of 8.8 and 10.1 percent of GDP, respectively. Because of these changes, estimates of the remaining degree of undervaluation have narrowed over the past two and a half years.

As you may recall, Republican presidential candidate Mitt Romney said if he won the presidential election he would declare China a currency manipulator as a way to force China to stop what Romney saw as an attempt by the Chinese government to undervalue its currency as a way to promote unfair trade practices.

The report draws a sharp contrast to Romney’s approach and suggests that the US government is willing to continue its policy regarding exchange rates, which lessens tensions between both nations. Indeed, even while the US government has declared that China needs to do more to raise the value of its currency, US officials are probably reluctant to ruffle the feathers of the world's second largest economy. What this report and subsequent reports published during the Obama administration reveal is the US government’s recognition of the communist country’s efforts to reduce government influence on the RMB, while implementing policies that bolster a stronger free market economy.

Citing a number of examples that indicate the Chinese government is moving in the right direction, the report notes that in April of this year, the People’s Bank of China (PBOC), which is China’s central bank, widened the RMB daily trading band against the US dollar in the Mainland currency market from ± 0.5 percent to ± 1.0 percent. Explaining its decision, the PBOC said it took the decision “in order to meet market demands, promote price discovery, enhance the flexibility of RMB exchange rate in both directions, [and] further improve the managed floating RMB exchange rate regime based on market supply and demand with reference to a basket of currencies.”

For their part, high-tech manufacturers have been coping with a rising RMB, which translates to increasing costs associated with managing supply chains in China. This includes the cost of operating manufacturing plants and wage rates, as well as warehousing, transportation, and shipping costs.

Still, while the high-tech industry must bear these costs, another advantage for technology companies is the Chinese government’s intention to raise domestic consumption.

To this end, the report notes that in May, at the Fourth US-China Strategic Economic Dialogue, Chinese authorities restated their commitment to economic reforms and to policies that will achieve higher household incomes and consumption spending. These policies include interest rate reforms, lower taxation rates on consumer goods, and the development of the services sector, as well as shifting resources to consumers by raising the dividend payout rate of state-owned enterprises.

Chinese household consumption also received a boost in the summer when Chinese banks received the green light to offer greater flexibility in determining the interest rates they offer their customers. This is a change from the PBOC-determined interest rates, which set a ceiling on deposit rates, a floor on lending rates, and prohibited banks from lending at rates more than 10 percent below the announced rate.

Interest rate reform should have a positive effect on household consumption. The report states:

With the reforms in 2012, however, banks now are permitted to offer deposit rates up to 10 percent above, and lending rates up to 30 percent below, the official benchmark interest rates. Continuing to move toward market-based interest rates will help remove distortions in the economy that result when administratively determined interest rates do not accurately reflect the true cost of capital. A rise in real deposit rates also could lead to an increase in Chinese household consumption, because low real bank deposit rates have meant that Chinese households earned very little on their savings, which requires them to save more to meet their financial goals.

More spending power in the hands of Chinese consumers translates to more sales of PCs, laptops, tablets, smartphones, and other computer technology. With these trends unfolding, high-tech manufacturers can plan ahead and take advantage of a new crop of consumers that should have more money to spend to buy products with a stronger currency.

On the other hand, the high-tech industry must pay close attention to the rising value of the RMB and must prepare for a more costly Chinese manufacturing business climate. How they tackle this dynamic will be very interesting to see in the years ahead.