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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.

6 comments on “Let’s Not Fight a Currency War With China

  1. DataCrunch
    October 25, 2010

    Hi Bolaji, a trade war may be inevitable in the future.  Do you think China has been playing fair since its entry into the WTO nine years ago?  What are your thoughts on how Beijing treats outside competition when it comes to penetrating its domestic markets? 

  2. bolaji ojo
    October 26, 2010

    Dave, You asked all the right questions and there are many people in governments worldwide and at various companies wondering how best to answer these. In my opinion, we put the cart before the horse in the rush to embrace China decades ago. Twenty years or more ago, few people cared about why a comprehensive approach should be adopted with regard to the transfer of production and raw material sourcing to China. I recall working at a magazine called Asia Inc. in Hong Kong in 1993 and wondering how the wholesale transfer of not only production but also business intelligence from the West to China was going to turn out. It didn't feel right to uproot everything from one location and move them to another without thinking of the long-term cost.

    I explored the above because this is what lies at the root of the engagement discussion currently with China. Governments and companies are now wondering if they moved too quickly in shifting production and the procurement of raw materials to China without requiring a similarly beneficial response from the Chinese government. It is probably too late right now to redress this unless we want to put the global economy in a chokehold.

    I think the questions you asked are best treated in a column and I would like to do that later this week and give the rest of our readers a chance to dive in. Perhaps you could treat it yourself in a message board posting.

  3. Barbara Jorgensen
    October 26, 2010

    Dave and Bolaji–right on. Those are the questions at the heart of the matter. Numerous blogs and comments on our site and others indicate the massive move to China was too quick and in many cases not well thought out. But many in the U.S. continue to blame China for our poor planning. China's is not an open market; its policies are protectionist and it continues to throw red tape at foreign companies that want to do business there. I don't recall China promising otherwise–I think we expected it would fully embrace our notions of capitalism and act accordingly. Turning the tables and fighting back with tariffs is not the right thing to do–the U.S. needs to look inward for the solution–not “penalize” a country that is taking advantage of its current good fortune. What country hasn't done that at one time or another?

  4. Hawk
    October 27, 2010

    Barbara, We all may not want, like or encourage it but a trade war with China is inevitable if no changes are made. The balance of trade currently is too weighted heavily to one side and the social impact is beginning to put pressure on everyone in the West negatively. Just because China never promised that it would do anything other that act as a closed society does not mean we accept the continued hollowing out of jobs in the West. The price of such an approach to this problem is political and social upheaval. Does anybody in the West want that and does it bother China's government that instability may be the result of its economic policies at the overseas customers.

    What's the solution? Chinese officials must begin to accept that their country's future is tied to the success of its national business partners and respond accordingly. They cannot continue to shut off parts of their society and keep their currency artificially high and not expect the West to demand and insist on reciprocal terms. Of course, China can ignore the West and maintain its current stance. It will find out soon enough the sentiments and concerns against its currency policy run deep and could hurt it on a longer-term basis.

  5. Backorder
    October 28, 2010

    I think the mood is summarised by what transpired at the IMF annual meeting recently.The treasure secretary chose to bash China’s unwillingness to allow the yuan to rise. China is on the offensive targeting the expected “Quantitative easing” as being problematic to world economy. China's excess reserve, expected to hit $ 3 Trillion by 2011, and the currency control is no doubt distorting the world trade scenario, however, what I find interesting is how the policies in developed western economies can impact the global scene. I mean, if the Fed resorts to minting money and buying bonds, it just might swamp emerging economies with excess capital inflow and end up destablising them. I would like to hear what you guys think.

  6. Barbara Jorgensen
    October 28, 2010

    Hi Hawk,

    I agree–China wants to isolate its fate from the rest of the world's (ROW) and I don't think that's possible. And trade is heavily skewed in its favor. But I also think ROW still wants to buy cheaper goods. Short-term, a trade war will hurt consumers at the worst time possible–at least in the U.S. with unemployment so high.

    U.S. manufacturers went to China willingly, and I still think it is up to them to change their strategy if China is no longer working in their favor.

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