Title: Chinese currency revaluation no panacea

Sub-title: Experts say allowing the Chinese renminbi to rise will provide a shot to Canada’s economy. But it won’t happen overnight.

 

China’s emergence as a global economic power has done wonders for Western consumers. Cheap Chinese labor has helped drive down prices on a wide range of goods, from textiles and toys to electronics products. The Chinese manufacturing sector has been credited for almost single-handedly helping keep inflation under control in many parts of the world.

 

However in recent years there has been growing criticism that China, which has long pegged its currency to the US dollar at an artificially low rate, has an unfair advantage. Earlier this year the International Monetary Fund let it be known that though the renminbi was substantially undervalued. This favors Chinese companies relative to Canadian competitors in two ways: it makes Chinese goods cheaper in foreign markets, and it makes Canadian goods more expensive in China.

 

Many politicians, notably US senator Chuck Schumer agree, and have been pushing China to revise its stance. Last month, during the lead up to the G-20 summit, the People’s Republic Bank of China (PBOC) finally bowed to those and other pressures, by announcing that is would increase the renminbi’s “exchange rate flexibility.”

 

While the Chinese government hasn’t committed to fixed targets, the last time it opted for currency relaxation, it allowed the yuan to rise by close to 20 percent over a three-year period between 2005 and 2008. Experts expect a similar gradual appreciation this time around too. Carlos Leitao of Laurentian Bank Securities expects the cumulative increase to eventually reach as high as 30 percent.

 

Not a panacea for Canadian manufacturers

Hendrix Vachon, an economist at Desjardins Group says that although such a move could provide a boost to the Canadian economy, the benefits should not be overestimated. “The policy is welcome because over time it will make Canadian exports more competitive,” said Vachon. “But it is hardly a panacea.”

 

There are several rather technical reasons for that. For one, as Krishen Rangasamy, an economist at CIBC WorldMarkets points out, even if the yuan rises, the prices that Chinese companies charge for their exports are unlikely to rise by a corresponding amount. That means Canadian manufacturers of substitute products won’t gain much of an advantage.

 

That’s because many products that Chinese companies manufacture include significant proportions that are made elsewhere. For example if a Chinese computer manufacturer imports memory chips, cases, software and processors, and then slaps them together and re-exports the finished product, only the Chinese costs, (such as labor) will be affected by the exchange rate move.

 

“The domestic component of Chinese exports is between 35-55%,” notes Rangasamy. “Even assuming the upper bound of that range, a yuan revaluation of 17 percent would at worst raise the price of Chinese imports by 9 percent.”

 

Vachon agrees that a yuan revaluation will boost the competitiveness of Canadian exports, however he notes that all sectors will profit equally from the change.  “Right now Canadian exports of manufactured and high value added products to China are quite modest,” said Vachon. “However raw materials exporters stand to make big gains over time, particularly if the global economy picks up steam again.”

 

How will interest rates be affected?

Another serious question relates to the degree to which North American interest rates would be affected if the Chinese currency becomes more flexible. For the past several years, the PBOC has been using much of the cash that Chinese firms earn from their US exports to buy massive amounts of US dollars, purchases that have gone a long way to pushing down interest rates there and to keeping the greenback strong. If those purchases were to slow or end, the yuan would rise, but so too could interest rates. This could potentially put a big drag on the US economy and Canada’s too.

 

Leitao though isn’t worried. “Any rise in the yuan relative to the greenback will almost certainly be accompanied by a corresponding reduction in America’s trade deficit with China,” said Leitao. “This would do a long way to helping keep US interest rates down.” Let’s hope he is right.

 

Peter Diekmeyer (peter@peterdiekmeyer.com) is a Montreal-based freelance business writer.

 

 

 

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