In a very bad bit of news for the US, the Los Angeles Times (hat tip Lune) reports that the Chinese policy of letting the yuan appreciate has not succeeded in reducing the country’s massive increases in foreign reserves. In fact, the situation is getting worse rather than better.
Normally, when a country’s currency appreciates, its current account surplus drops, as does foreign direct investment (the notion being it will be a less competitive exporter). But in China’s case, the usual pattern isn’t operating. From the Los Angeles Times:
In 2006, the yuan rose just 3.24% against the dollar. But since the second half of last year, the appreciation has accelerated amid a sharply falling dollar and surging inflation in China. Chinese policymakers figured a stronger yuan would boost imports and curb excess exports, thus slowing the growth of China’s trade surplus and the flood of dollars into China that has pushed up inflation.
So far, though, the yuan’s sharp rise hasn’t staunched the massive inflows of cash. In fact, China’s foreign reserves, the largest in the world, have ballooned to $1.65 trillion this year, with about $60 billion added in January and in February — up from a monthly average of about $40 billion in 2007.
With the yuan appreciating quickly, speculators are continuing to pour money into China, says Michael Pettis, who teaches finance at Peking University. Nor is there clear evidence, he says, that the stronger yuan is reducing China’s trade surplus, even though lower demand for goods from the U.S. appears to have slowed China’s export growth recently…
Although the stronger yuan makes U.S.-made goods cheaper for customers in China, Zhang Renren, manager of a U.S.-based wood exporter, said that hadn’t translated into a noticeable pickup in orders from China.
The article does report that Chinese firms are looking at moving operations into lower-cost Vietnam and also observes:
Wessco [a US company that has its products made in China] also hopes to move up the value chain and take advantage of China’s growing pool of skilled and creative talent — still cheap by Western standards. Two months ago, Sakkis said Wessco opened a design office in Shanghai with a staff of 10.
With the yuan and other costs rising, he said, China as a production base for low-value goods is yesterday’s news. “We’re shifting how we look at China,” he said.
Note that Wessco is hardly alone in looking to China for higher-value added manufacture; this repositioning was frequently mentioned at a recent presentation at Asia Society.
Where does this leave the US? Not in a pretty position at all. Having become a service economy and sent so much manufacturing overseas, a cheap dollar may not produce the benefits the US hoped to achieve. Indeed, the US trade deficit widened in February, contrary to expectations. Even though economists argued that this month was a one-off due to unexpectedly high import demand, the confidence that this pattern will change soon may be misplaced. The main contributors to the blip up were purchases of foreign cars, computers, and oil. The oil part of the equation won’t change, computer manufacture is offshore and thus not likely to shift soon either. The buys or non-US cars and computers reflect consumer preferences that may prove stubborn as well.
With a limited manufacturing base, it remains an open question how much improvement we will see in the balance of payments even with continued debasement of the currency.