June 22, 2005

Blurb: China's rapid growth provides Canadians with numerous benefits.

The China factor

By Peter Diekmeyer o Bankrate.com

China's breathtaking emergence onto the world stage, the speed at which it has lifted millions of its citizens out of poverty and the prospect that it will one day be the planet's biggest economy have captured Canadians' imagination. It seems like the word China is on everyone's lips these days.

Ironically much of the coverage has focused on the negative implications. Dark clouds run the gamut from the Middle Kingdom's growing military might to fears about intellectual property piracy.

The main worry, of course, is about the potential job losses resulting from Canadian purchases of Chinese products. "China's rising production of manufactured goods represent a serious competitive challenge to other producers around the world," said Paul Jenkins, senior deputy governor at the Bank of Canada, in a recent speech, "especially during periods of relative economic weakness and subdued employment growth."

But while the rapid emergence of any new power on the world scene is bound to create adjustment issues, China's growth has been on balance mostly positive for Canadians. And many of the potential negatives are not as bad as they seem.

For example, Canadian purchases of Chinese goods often do not lead to direct job losses as is often claimed. In fact Chinese imports are often goods that Canadians had previously bought in other Asian countries such as Taiwan or Japan, but which we can now buy cheaper in China. Almost no one predicts that Canada's textile and other light manufacturing industries, which moved overseas during the 1980s and 1990s, are coming back.

In fact, the Middle Kingdom's rise has been good news for Canadians almost across the board. Benefits include its effects on domestic inflation, interest rates and economic growth.

Goods inflation at near-zero levels
One of the most obvious benefits that China's emergence has provided Canadians is its effect on their pocketbooks. Canadians imported $24 billion worth of Chinese manufactured goods last year, an increase of 30% from 2003. Almost all of these goods, which range from toys, tools, shirts and games to higher end machinery, have one thing in common: Canadians paid less for those products than they would have had they been made somewhere else.

To gage the effect one only has to look closely at Canada's inflation picture. Canadian inflation generally tends to fall into the Bank of Canada's 1% to 3% target range. But if you look at little closer at the numbers, a more subtle picture emerges. In fact the vast majority of the increases in Canada's consumer price index in recent years have been in services prices, such as the cost of getting your hair cut, tax returns completed and so on. If you look at a multi-year graph of goods prices, it looks like a straight line hovering around zero.

China's emergence has been a key factor in keeping inflation low almost all around the world. That effect is felt not only in sectors in which Chinese companies compete, but in other sectors as well. Often the mere threat of Chinese competitors entering a market, is enough to prevent companies from increasing prices.

Ironically the sectors in which China's emergence has boosted prices, -- energy and raw materials products,-- these movements have played largely to Canada's advantage, because we are net exporters of both. As one expert put it, "...for everything we sell to them prices are going up and for everything we buy from them prices are going down."

Chinese security purchases help keep interest rates low
Another area in which the emergence of the Chinese economy benefits Canadians, has been its effect on interest rates. Because China has such a massive trade surplus with the U.S., it has to do something with the money it collects.

But instead of spending it all domestically, the Chinese have been using the excess cash to buy U.S. securities. That provides a big advantage for the American economy, which has been struggling to finance its huge trade and government deficits.

Massive Chinese purchases of U.S. securities help keep U.S. interest rates down, which in turn helps us, because Canadian rates largely track those south-of-the-border. It's almost impossible to estimate the "China effect," on Canadian interest rates, because there are so many variables in world financial markets. But if massive Chinese purchases of U.S. securities kept interest rates 25 basis points lower, that would be worth about $6,000 to a home buyer with a 30-year $100,000 mortgage.

Contribution to Canada's economic growth
Another key benefit provided by China's emergence to the Canadian economy is the Middle Kingdom's effect on the world economy as a whole. China's growth is now so vast and so fast, that it, along with the U.S. is now one of the two main drivers of world economic growth.

That plays out directly in terms of Canadian job creation, because a richer China has more money to buy goods from us. Canadian exports to the Middle Kingdom have more than doubled in the past five years to $6.6 billion in 2004, from $2.7 billion in 1999.

One of the big questions is how China's growth will be affected if Chinese government bows to pressures from the U.S., and other countries to re-value its currency.

Critics have charged that by pegging the yuan at a relatively low rate relative to the U.S. dollar, the Chinese government is providing local firms with an unfair competitive advantage. The fear is that if the currency peg is changed, the Chinese economy, ----which is expected to grow in the 8 to 9 percent range this year,-- would suffer.

But not all analysts agree. According to Sherry Cooper, executive vice-president of BMO Financial Group, any re-valution is unlikely to happen soon. And when it does occur. it would be phased in gradually, thus reducing its effects. "Chinese exporters would likely squeeze profit margins further in order to maintain market share," comments Cooper. "They are not motivated or rewarded by profits, only by expansion."

Canadians had better hope so. Because with all the benefits they are getting from China's emergence, they have a big stake in the outcome.

Peter Diekmeyer (www.peterdiekmeyer.com) is the Montreal Gazette's management columnist.



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