China’s Exporters Hanging by a Thread?

Has the Chinese export sector become hostage to WalMartization, the ability of powerful retailers to squeeze vendor profit margins? Reader Michael Q called our attention to a key remark in a Wall Street Journal story:

Vice Commerce Minister Zhong Shan, in an exclusive interview Thursday ahead of a visit to the U.S., said that the profit margin on many Chinese export goods was less than 2%.

Most exporters absorbed the appreciation in the value of the yuan that followed its revaluation in 2005 by boosting innovation and cutting costs, but many were forced to close, he said. A further rise in the currency’s value would endanger more exporters’ survival, which China can’t afford, he said.

As Michael Q, who is an equity analyst, noted:

2% margins on export-oriented businesses is not representative of any sort of real competitive advantage. A real competitive advantage when it comes to exporting would show double-digits profit margins. This whole sector is hanging by a thread…nearly none of the activity China has engaged in since the downturn is secular or self-sustaining.

Yves here. The implications for China are serious. First, this says that it perceives it has no room to revalue the RMB upwards. Not only are exporters politically powerful, but on a more mundane level, the regime has achieved social cohesion through a promise of rising prosperity. Too much unemployment would undermine the legitimacy of the governing classes.

But second, it also implies China cannot even tolerate much inflation. Remember, inflation will push up the price of good in local currency terms, which in a fixed peg currency regime, translates directly into price increases. Price increases from a country whose selling proposition is cheap prices would lead importers to look for substitutes in other emerging economies. A 2% margin not only says manufacturers have no room to cut prices, it also says they cannot afford much in the way of lost revenue.

This dynamic makes the idea floated on the blog earlier, that China might devalue the RMB, less radical than it might seem.

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  1. i on the ball patriot

    Walmart cut scamerican inventory by 1.8 billion last November. I don’t know what the product source mix is, but it is heavily weighted towards China. The local Walmart (NE Florida store) now has zero goods in those big wide promo aisles, it almost looks vacant …


    “Continuing the theme expressed by other companies in this global economy, profit increases were facilitated by productivity and cost control improvements including fuel savings. Wal-Mart reduced inventory in its U.S. stores by $1.8 billion, which is quite a significant amount. The company’s internal green and sustainability initiatives have no doubt had some impact on reduced fuel savings in private and store facilities. It was also noted that the company would focus on continued expense control as it moved into the critical holiday season.”

    Deception is the strongest political force on the planet.

  2. bobh

    This fits in with the Robert Brenner thesis, cited here by Yves last December, that the developing economic and financial turmoil in the world is largely due to global productive capacity exceeding demand.

  3. cas

    If China devalues Yuan it response to its predicament(low margin and inflation creeping up), is this action considered currency manupulation? It would seem to me this action is in respond to market forces and therefore legitimate or may be not?

    1. Yves Smith Post author

      What China is doing already (keeping its currency so cheap that it has to buy tons of $ assets to keep it from rising) is ALREADY currency manipulation, even though we have not officially called it that. To drive it down to preserve export competitiveness is a more blatant example of the same behavior.

      1. john bougearel

        At least one economist begs to differ with US senators and lawmakers that claim the Chinese Yuan is undervalued.

        “U.S. lawmakers are playing political football by pressing China to boost the value of its currency, which isn’t particularly undervalued, Goldman Sachs Group Inc. Chief Economist Jim O’Neill said yesterday at a press conference in London.”

        What if O’Neill is right and lo and behold, the lawmakers are wrong? What if the lawmakers are simply telling a worn-out China scapegoating story that sounds compelling to their constituents, so they are seen as trying to do something and to win their votes at the mid-term election?

          1. Yves Smith Post author


            There have been analyses of this sort for YEARS, and for the most part not by sell side analysts. Believe me, the notion that the RMB is being pegged at an artifically cheap level is not a controversial idea.

        1. alex

          Goldman Sachs is not high on my list of disinterested or reliable sources of financial information. The model they use to claim the yuan is not undervalued is proprietary. Instead of answering how it works, they say “trust us”. What’s your response to GS saying “trust us”?

          1. a

            In particular GS is not reliable about China because they have an incentive to toe the Chinese government line, which is they hope to be rewarded for their good behaviour with Chinese deals down the line.

            GS does this all the time, putting out “analysis” which is just intended to push the interests or book of GS.

        2. steve from virginia

          The dollar is a hard currency, the world’s economy is boiled down to buying and selling money, the Chinese have the largest hoard of dollars outside the US (outside the charmed circle of ‘Bennie’s Friends’). Of course the establishment wants China’s dollar reserves.

          With the dollar pegged to irreplaceable crude oil, China MUST devalue or it will simply crash in a deflationary bubble- collapse. There is no way around it and China knows it.

          Saudi Arabia is making monetary policy for the US and will wind up with China’s reserves. Saudia and China both LIVE peak oil while the US childishly denies it. Let’s see how this fiasco plays out …

          Hard currencies running amok; see Latvia for the future of the US …

    2. i on the ball patriot

      cas asked; “If China devalues Yuan it response to its predicament(low margin and inflation creeping up), is this action considered currency manupulation? It would seem to me this action is in respond to market forces and therefore legitimate or may be not?”

      A better question might be are market forces legitimate when central banks are manipulative?

      Deception is the strongest political force on the planet.

  4. Ishmael

    From just dealing with the Chinese all I have to day is never believe a word they say. I do not believe what most people say but that goes doubly true here.

    A saying I always remember goes as follows:

    An asian has three faces, one face they show to most people, the other face they show to friends and family and the third face they keep to themselves.

    Vice Commerce Minister Zhong Shan indicates they have a 2% margin. Why should we believe him. What people say and what the truth is are two seperate matters.

    1. Yves Smith Post author

      There is other evidence that the Chinese economic model is under considerable stress. The most damning is the very large amount of debt it is taking to produce an incremental dollar of GDP. IIRC, it is now $7 of debt for every $1 of GDP growth, an astonishingly high level for a developing economy.

      1. alex

        You’re scaring me. My initial response to Zhong’s 2% claim was, yeah, you can always trust Chinese government statistics. But if there is independent confirmation this is truly scary – the yuan has to increase (or we have to impose tariffs), but an unstable China is not a pretty thought. Will it at least be good for defense stocks?

        The only hope I can cling to is that your $7 of debt for every $1 of GDP growth is also a reliable Chinese government statistic.

        1. Detlef

          I read a (business) newspaper article a few days ago. As far as I remember it mentioned that the Chinese overcapacity in steel production was now larger than the entire steel production of Europe (or EU?). I was looking for something else so I didn´t pay that much attention to the exact quote.
          If that´s true then low profit margins in that sector would be understandable.

          Likewise I believe there were quite a few articles in 2009 warning that one of the results of the surge in loans back then would be even larger export capacities in China. Each province on its own trying to boost its exports and economy. That overcapacity too probably wasn´t exactly needed in a recession.
          That might have led to Chinese companies competing fiercely with each other for any contract just to stay “alive”.
          So, that 2% claim might be true for quite a few export sectors in China.

      2. mxq

        if we recall way back in 2008, during the heart of the downturn, it was reported out of china that67,000 export-driven businesses went under during the first half of that year. it was estimated to have gotten as high as 100k bk’s. that is a systemic failure in my own opinion. again, in my own opinion, the only way such a massive failure could happen is by having an entire industry operating on a razor’s edge.

    2. Carrick

      I second this skepticism.

      Is there any way to verify his figure?

      I don’t see a Chinese official giving any information (particularly about how vulnerable their exporters are) unless it served them well. Why would they do it publicly?

      Doesn’t a statement like this just say one thing — “ANY currency-related action (by you or us) is going to result in increased costs for US companies.” Whether those companies have to relocate production, cut their profit margin (b/c Chinese manufs are “squeezed”0, or deal with tariffs.

      Sounds like a great way get U.S. businesses to bear pressure onto Congress/white House in advance of his visit.

      They don’t seem to have a lot to lose by advertising this. Companies can always go to their Chinese manufacturers and find out there was more than 2% to shave off. At the very least, it might be a nod to domestic manufacturers that helps get their US clients off their backs.

      This is a face saving culture too. Granted, Asians are prone to inflating their wealth in general (as a face thing), but if they were truly in a delicate situation would they be broadcasting it? Also, is this same figure common in Chinese-language media, or js it just for Western ears?

      They’ve got nothing to lose. I just don’t see a chinese official playing it totally straight with the U.S. ever. We’re not talking to a historical ally here like France or England, or even Germany. China never plays it straight with the U.S., so they don’t really have a reputation they’re worried about tarnishing.

      1. Yves Smith Post author

        The high rate of borrowing relative to GDP growth is consistent with razor thin profits. Companies usually fund most of their investment needs (and remember ANY business requires reinvestment on a continuing basis, capital and other equipment wears out or breaks, you need to replace it, and you also need to invest in R&D, new product development, etc, at a minimal level to keep up with competitors). Borrowing is usually a secondary way to fund growth, usually limited to big equipment purchases or acquisitions of businesses (although it is often used on an ongoing basis to fund working capital, but that should not be a significant factor in funding for growth).

        So a high level of borrowing relative to GDP growth confirms the thin profit thesis.

        1. bob goodwin

          In many cases profit margins have gone underwater, and businesses are just holding on using easy credit. I have no direct evidence, but know anecdotally that there has been a not-so-subtle increase in chinese ODMs propensity to cut corners wherever they can, to shave costs by changing processes and materials when their customers are not looking. It is a lot of effort for a foreigner to get quality product out of China, and lately it has been even harder. When your margins approach zero, quality and customer satisfaction become too expensive.

        2. jake chase

          This is just plain silly. Chinese statistics are fabricated out of thin air. Businesses depend upon political influcence. Capital is allocated by Communist apparatchiks. Nobody tells anybody else the truth. You can’t use business school bullshit to analyze China. Take a look at a book, Poorly Made in China, which provides a taste of reality.

    3. Jeff

      I know this is true because as a friend and colleague working with an ODM manufacturer in Taiwan and China as a consultant, I have seen the Bill of Materials. I work with more than one Original Device Manufacturer, actually, but I’m thinking of one specifically.

      And since I set the test processes, I’ve seen the time costs. My client is the OEM, who buys the branded product so I know the price.

      It’s very scary. The whole thing is a race to the bottom, the cause is all the spare capacity bidding for the same production runs. The quickest way to build a really good relationship with a company with China based manufacturing is help them build a product their competitors can’t bid to just above the marginal cost of manufacture. Seriously.

      1. bob goodwin

        Anyone working with a Chinese ODM knows that there are two sets of books when it comes to bills-of-materials. There are side deals all the time to make sure that the customer thinks that the materials are more expensive than they are. Because large US manufacturers are on to this, there are semi-formal ways that ODMs and their suppliers report piece part pricing so that there is consistency across the industry on how they cook their books. I am not arguing that there is any margin left, just don’t believe the BOMs.

  5. john bougearel

    Au Contraire, Yves

    This just in from BB today:

    March 18 (Bloomberg) — China is conducting stress tests to gauge the effect of yuan appreciation on companies…The China Council for the Promotion of International Trade is conducting yuan tests at more than 1,000 companies in 12 industries, Vice Chairman Zhang Wei told a press briefing in Beijing today…China has kept the yuan little changed at around 6.83 per dollar since July 2008 to help exporters survive the global financial crisis….Processing manufacturers, such as textiles and furniture makers, which have profit margins as low as 3 percent, would “immediately face bankruptcies,” according to Zhang…“Even if the yuan has a slight appreciation, they’ll be dead,” he said. The results of the tests will be announced before April 27, said Zhang

    Zhang is speaking more like a capitalist that allows strong swimmers to survive and weak swimmers to die than his counterparts in the US who are ever-so-busy building mythical too-big-to-fail models. Funny how the US Empire now embraces policies that endorse communist/socialist/fascist/corporatist models that it once eschewed as evil from 1940-2007.

    Looks like the US will have more than a wee bit of egg on its face if China lets the Yuan rise in Q2 2010 and its export companies that fail the stress test on April 27 to actually fail.

    The US Congress efforts to strongarm China into letting the Yuan appreciate will make China a far better capitalist economy than the US.

    Those who love capitalism are going to grow more than a bit envious of China. When all is said and done, the US govt may not be able to save capitalism from its self-destructive tendencies as Paul McCauley had hoped might be possible.

    1. Yves Smith Post author


      The link you provided further supports the point of the post.

      1. The RMB is being kept artificially cheap. That is the US contention, and the overwhelming majority of economists agree.

      2. An artificially cheap currency functions like an export subsidy.

      3. Even with that subsidy, Chinese exporters are barely profitable. A 2-3% level of profit is insufficient to fund maintenance investments in the business (replacing depreciating equipment), let alone finance growth.

      4. So if we see widespread business failures in China with RMB appreciation, that supports the US thesis, these were not viable businesses, but creatures of state support.

      Further, I do not see how you can conflate subsidized enterprises dependent on export subsidies with capitalism.

      1. john bougearel


        It looks like China is signaling their intention is to bury these subsidized enterprises dependent on export subsidies with their paper thin margins. That would be a move away from a subsidized model towards a capitalist model.

        We shall see…

    2. alex

      john bougearel: “Zhang is speaking more like a capitalist that allows strong swimmers to survive and weak swimmers to die than his counterparts in the US … Looks like the US will have more than a wee bit of egg on its face if China lets the Yuan rise in Q2 2010 and its export companies that fail the stress test on April 27 to actually fail. The US Congress efforts to strongarm China into letting the Yuan appreciate will make China a far better capitalist economy than the US. Those who love capitalism are going to grow more than a bit envious of China.”

      I’m sure that China will be a capitalist paradise just as soon as they purge the rottenness out of the system. It will strengthen their economy just as the Great Depression strengthened ours. And in the long run we’re all dead.

    3. bob

      I saw that story and laughed out loud.

      Once again all China seems capable of is immitating the US. Stress testing will lead to a ‘pass’ which will lead to no change. The ‘branding’ of the stress test has reached its pinnacle. Maybe we can ask for some royalties.

      It just buys time.

      Nothing to see here, keep moving.

  6. /L

    Vice Commerce Minister Zhong Shan can be right he can be wrong, could we expect him to say otherwise in current China bashing times, talk is one thing can he show some hard facts that underpin his talk. But that there are slim margins is probably not farfetched.

    When we have a problem, we usually look for the causes internally. However, the U.S. tends to look for reasons from the outside. There’s a cultural difference between our two nations,” Mr. Zhong said.

    But there is albeit some similarities.
    “When we have a problem, we usually look for the solution on the outside. However, the U.S. also tends to look for solutions from the outside. There’s a cultural similarity between our two nations,”

    As an example of these differences, he said that more than a decade ago when he was chairman of a Chinese textile trading company he noticed that when U.S. business executives visited China “they said they must fly first class and stay at five-star hotels.” He claimed he never awarded himself such luxuries. “I wanted to save costs and ease pressures within the company starting from the position of chairman,” he said.

    Give me a break, I don’t doubt that Minister Zhong Shan is a bearer of true ascetic commie values promoted by CCP. But never the less it seem like there is other in the Chinese export establishment that succeed to squeeze out some lavish lifestyle out of those two meager percents, somehow we have been used to headlines as this from cultural frugal ascetics buddys of Minister Zhong Shan:

    China Tops US As Bordeaux’s Top Export Market Outside Of Europe …
    Experts say China is the best thing to happen to the luxury companies’ bottom lines since the Japanese became addicted to logos in the 1980s.

    GUANGZHOU: Construction of a 250 million yuan ($36 million) garden in the Panyu district, including a toilet facility inlaid with gold, is stirring up controversy in this Guangdong provincial capital. …
    The garden’s buildings were gilded with more than 10 km of pure golden leaf and mounted with more than 200,000 pearls and jewels in its doors, windows and outer walls of the garden’s pseudo-classic architectures.
    In the garden, there are intricately carved beams, painted pillars and the glitter of gold and jade on all sides. … most of the construction funds came from the Panyu district government.

    And more culture nonsense from Mr. Zhong:

    There’s nothing that can’t be discussed between China and the U.S. But if you pressure us to do something, that’s not in line with China’s culture,” Mr. Zhong said

  7. Vox

    They are stuck.

    If they keep the rates low, it will push inflation and destroy their margins. Since they are pegged to the dollars, they cannot raise the rates. They will either have to give up the peg or buy a huge amount of treasuries.

    Dunno how they are going to pull this one off.

  8. run75441


    Interesting, little of the legislated overhead for labor and little of the customary overhead such as healthcare, 401k, vacation, etc. Low labor costs, capital overhead cost, materials cost, and a long supply chain. Interesting dilemma. I wonder if they are as efficient as they claim to be or else they are lying.

  9. don

    I think a renminbi depreciation is quite possible, especially if it turns out that China can’t handle a property bubble much better than anyone else. Foreign currency purchases are a very effective form of stimulative fiscal policy. If the economy gets in trouble, China is likely to step up its use of this tool, especially if its domestic real estate investment sputters and stalls. In this case, we may see a renminbi that adheres to no particular level, but may fall in order to accommodate the currency purchases. That is, the goal becomes the amount of currency purchases rather than the level of the renminbi. The same effect could be obtained with government commodity purchases, though these markets are too thin to support much weight. Another tack would be to buy up nonfinancial assets abroad.

  10. scharfy

    I’m no expert, but it would seem likely that Chinese exporters are operating on paper thin margins. The MNCs that shop there are no doubt quite thorough in shopping around for the best slave labor price to assemble their widgets.

    This is not to discount the saber rattling of Mr. Zhong Shan. He’s throwing up his guard.

    They will keep the peg and blame the West for over-consuming. In the end the winners will be American MNCs, Chinese factory owners. Losers will be labor in both nations. Chinese will work too cheap, and Americans won’t have jobs.

    They are roughly where we were @ the turn of the Century. Export powerhouse on slave wages.

    As a remedy, we could send a few Union reps over there to get things going. That would get their labor costs up.

    Send them Andy Stern.

    1. scharfy

      One more “outside the box” solution:

      Have a representative from Goldman Sachs sit down with Mr. Zhong. After a brisk sales pitch, China will come to its senses and do a giant, “Greece-style” currency swap for all 2.5 Trillion of the reserves. Thusly, they can revalue without actually revaluing, and go on with exporting.

      Goldman can take their 5% fee of 125 billion, bonus out 50 billion, and buy – I mean actually purchase and take title to – Congress for the next 25 years.

      They will then enact laws to unwind the trade onto the Taxpayer in the interest of systemic risk.

      This all sounds farfetched but I swear I’ve seen it done before.

      1. purple

        Goldman can take their 5% fee of 125 billion, bonus out 50 billion, and buy – I mean actually purchase and take title to – Congress for the next 25 years.

        The US Congress would come a lot cheaper than that.

  11. fromchina

    The 2% margin actually overstates profitability, on a purely operational basis. Many Chinese export businesses lose money these days. They survive only by government subsidies.

    But I would caution not to read too much into those numbers. Those sweat shops come and go frequently. Even if half of them are closed, if conditions are right next year or next quarter, they’ll all come back quickly. The underlying infrastructure is always there. Hiring and laying off peasant workers in China are far easier than anywhere else in the world.

  12. Jake Watts

    Who is going to take over China’s export businesses if their costs increase for whatever reason? What other country(ies) could possibly step in and produce the goods that China does?

    1. Martin

      China is already since some time now claiming, that the low value products are under pressure e.g. from Vietnam. If you move up in the value chain, you might go to Malaysia or Eastern Europe. And then China has already products, where it is competing with corporations, that are still sitting in Japan, the US or Europe.

  13. MrK

    To sustain Ponzi Scheme in US and Europe ,western elites try to force China into self destructive path like they did to Japan in late 80’s. ZIRP policies are currency debasement policies. So is US not a currency manipulator?
    China is following a development strategy serving its interests. To understand them you have to understand F. List, a 19 century german economist.

    1. Yves Smith Post author

      With all due respect, I worked for Sumitomo Bank then, the first gaijin hired into the Japanese hierarchy. Sumitomo was the lead member of its group, and so I had a vantage not on what Sumitomo was doing, but a reasonably large sample of Japanese companies. I saw Japan drive itself off the cliff all on its very own. And I tried desperately to prevent Japanese companies from overpaying for US assets, and it was Tokyo based staff, keen for lending and deal fees, who undermined me.

      The US most assuredly did not “force” Japan into a real estate and resultant stock market bubble (stocks traded up both based on implicit land value of companies plus companies borrowing to speculate in stocks as well as foreign investments). The banks chose to lend 100% against the “value” of urban land, a value that was dubious because center city real estate never traded. They were similarly lax about lending to US LBO transactions.

      1. Cathryn Mataga

        Cool, did you learn any Japanese language?

        日本語が分かりますか。  私は日本語を勉強しているけど
        まだ聴解とても下手です。  日本語とフィンランド語を
        話すようになりたいんですが。  先祖の言語です。

        1. Yves Smith Post author


          I learned some spoken Japanese, but never how to read or write it.

        2. KD

          Hi Cathryn,

          “聴解” is a very difficult word. We don’t say it daily. I guess you learned it in Japanese listening tests. I’m afraid that none of us would not understand if you say “聴解”. “聞き取り” is a more casual word.

          Anyway, good luck for your learning. I have to improve my broken Engrish. Oops, sorry. It’s English.

      2. Edward Lowe

        Oh dear … Cathryn … or is it Naoka… anyway … it seems only the round eyes are capable of malfeasance and incompetence. Must be the Indo-European roots.

      3. MarcoPolo

        The more I know about you the more I can relate having come from
        similar background. Though I never had the credentials to meet people connected to MoF. Went it alone.

        1. Yves Smith Post author


          It isn’t a matter of credentials, it it a matter of being situated in an institution that has access. Look, in theory I have credentials, right? Big brand names on my resume. Virtually no one will talk to me. I am is a blogger who happens also to run a small consulting firm. That means I am in Siberia as far as the legitimacy hierarchy is concerned.

          I learned that lesson big time when I left Sumitomo, which in the days of Japan ascendancy was a sexy job. People who faked being my best buddy would not return my calls. Never mistake position for real reach/influence.

    2. Adam

      ZIRP policies are only debasement policies when they translate into inflation (and only when it intentional is it currency manipulation). For the past 20 years Japan has followed ZIRP policies and continues to suffer from deflation, not inflation. Everyone is convinced that ZIRP policies will lead to inflation here, but what’s the evidence?

  14. lark

    Yves, this is very interesting.

    It implies that a significant part of our global imbalance relates to Wal-Mart business model and how it squeezes suppliers. There was a very interesting article in Harpers a few years ago that examined monopsony (one buyer, muliple suppliers) which used to come under anti-trust enforcement, until Reagan trashed all that. It used to be that a company with tactics like Wal-mart would be prosecuted for its practices. Now they are lauded – and at what cost?

    The upshot in the US of A was that, of Wal-marts 10 largest American suppliers in 1994, four were bankrupt ten years later.

    It is quite possible that Chinese exporter profit margins are paper thin. That will not change, nor should it change, the American resistance to the peg.

    But it may well be that part of the solution will be to crack down on monopsony via anti-trust enforcement.

    quote from link above:

    “Even if the American people did choose to bear the extreme political costs of monopoly, the particular type of power wielded by Wal-Mart and its emulators makes no economic sense in the long run. On the surface, it may seem to matter little who wins the great battles between such goliaths as Wal-Mart and Kraft, or between Wal-Mart and P&G. Yet which firm prevails can have a huge effect on the welfare of our society over time. The difference between a system dominated by firms built to produce and a system dominated by firms built to exercise monopsony power over producers is extreme. The producers that dominated the American economy for most of the twentieth century were geared to build more and to introduce new, to protect their capital investments against overly predatory investors, to raise price faster than cost, to show some degree of loyalty to workers and outside suppliers and communities. Wal-Mart and a growing number of today’s dominant firms, by contrast, are programmed to cut cost faster than price, to slow the introduction of new technologies and techniques, to dictate downward the wages and profits of the millions of people and smaller firms who make and grow what they sell, to break down entire lines of production in the name of efficiency. The effects of this change are clear: We see them in the collapsing profit margins of the firms caught in Wal-Mart’s system. We see them in the fact that of Wal-Mart’s top ten suppliers in 1994, four have sought bankruptcy protection. “

    1. bob goodwin

      Yes, Walmart squeezes margins. But they do this worldwide, so you cannot hang Chinese margins on Walmart. I have done some midsize manufacturing deals in China, and the ODMs lead with price. There is rarely any effort to differntiate themselves from their competition and little negotiation on terms or added value services. They expect their customers to take the low bid, and so they try to give the low bid. It was always a mystery to many of this how they made any profit. It was widely assumed they made their profit by cheating (overcharging us, or cutting corners), so we put huge efforts into pushing back. It may be that these businesses wanted revenue more than profit because they could monetize profitless revenue in a bubble economy.

  15. MrK

    I have a great respect for you pls don’t get me wrong. But let me elaborate.
    Japan sustained its post war development at fixed exchange rate of 360 yen to dollar and within few years forced to appreciate its currency up to 90 yen to a dollar. How can a relatively developed country deal with such appreciation without causing massive bubble.How could japanese financial inst. handle tsunami of liquidity and manufacturers keep their profitability without resorting to financial games.
    Only five years ago i met vice president of major japanese life insurer and since i work in travel industry and fluent in japanese i asked him in private why they keep buying US assets his answer was that they get pressured by the ministry of finance to keep buying.
    I can provide you many anectodal stories that japanese were forced to that path by US pressure and japanese elites were to meek to resist unlike current chinese elites. That is causing great panic among masters of the Ponzi game.

    1. Yves Smith Post author


      I was there, at the time, directly involved in this business. I ran the US M&A operation and my allies at the bank included quite a few people who had close contacts at the MoF (including the person at the bank who was officially responsible for dealing with the MoF). I had a seat at the table during the bubble years.

      This “the US made us do it” is complete revisionist history. No one had any reservations at the time, either at the banks or in policy circles, until after the bubble burst. No one felt forced to do these deals, it was seen at the time, both in the US and Japan, as proof of Japanese ascendancy.

      1. MrK

        That is the point, once you dupe japan at that time and china now to massive currency appreciation then the slippery slope to asset bubbles and financialization of the country is guaranteed.

        1. Yves Smith Post author

          This wasn’t “dupe”. Google Plaza Accord.

          And the only reason the US tried going this route was that Japan refused to dismantle substantial non-tariff import barriers. I will admit that the US probably overestimated Japanese receptivity to US goods, given Japanese skepticism about US quality standards. But the substantial formal import barriers also left a strong impression Japanese companies were not willing to play on anything even remotely resembling a level playing field. Had Japan been willing to lower import restrictions, the US would not have pressed so hard for the yen revaluation. And if you also look at the history, the yen overshot what anyone wanted, the US included.

          You are also exaggerating the degree of yen appreciation in the 1980s. It reached a peak of 127 to the dollar, when it had ranged mainly in the 225 to 250 range earlier in the decade. And the US is now asking only for a 5% increase in the RMB.

          1. fromchina


            I agree with you the US had legitimate reasons to impose the Plaza Accord on Japan. All of the hidden import barriers you alluded to are true. But in the minds of Japanese, that was “dupe”.

            Chinese and other Asians share that view, that’s why they’re resisting, and feel righteous in doing so.

            I really don’t think a 5% or even 10% revaluation would do anything to change trade balance. China can simply add subsidies to the export sector, which already amounts to something like a 15% margin.

          2. Yves Smith Post author


            I agree 5-10% probably won’t make much difference either, but both sides are now trapped by their posturing. China does not want to be seen to be bullied, and the US is in need to show some tangible progress after years of neglecting industrial policy (that is a dirty word here, of course, but we have it by default, by which sectors get government aid and tax breaks).

            The underlying problem is that most respectable economists agree now that it is OK for developing economies to have some protectionism to help industrial development. But when they become successful, then developed economies want them to become more open, and that forces adjustment onto the developing economy. We don’t have good ideas or rules of thumb regarding this process, so it becomes a power struggle.

      2. bob goodwin


        If the Japanese felt ascendency then, what do they feel now? (I am presuming you still have contacts?) Is MrK right that they feel victimized?

        All of my contacts are Chinese (although none at your high levels) have a deep feeling of ascendency (“will overtake the US within half a generation”), and positively deny there are societal or financial imbalances that are an impediment to their destiny.

        1. Yves Smith Post author

          The Japanese by temperament are more modest. The sense then was giddy, as if they felt if they kept at it, they’d eventually be super successful, but it arrived ahead of schedule. I’d say the ascendancy was perceived in the US much more than in Japan. You did have some displays of pride/nationalism that looked a little scary to outsiders (the book The Japan That Can Say ‘No” by Morita and Ishikawa and Ishikawa’s later I Still Say No, which went remarkably unnoticed in the West), but it was pale compared to what you see from China now.

          The people I know are in banking, they don’t seem to feel victimized, but that might be because they were all part of the group in power when Japan drove off the cliff.

    2. KD


      I’m Japanese. I’ve heard of the story like you wrote above. I know a former fund manager who worked for one of the major insurance companies in Japan. He once told me that if you didn’t buy US bonds, the Ministry of Finance called you and said, “Well, how about US bonds?” But he added that it’s years ago, so it’s not the case right now.

      I’m not sure if it really is, but you may notice that buying US bonds could not only cater to US interests but also be of great importance for Japan, because buying US bonds depreciates yen. Recently, it was revealed that Yucho Bank, Japan’s biggest commercial bank held by the government, bought about $30 billion US bonds late last year. Some analysts say it’s another type of currency intervention. Private financial institutions may not be forced to buy US bonds now, but the government is using public institution to buy US bonds.

  16. fromchina


    To follow the discussion about developing countries needing to be open when they are successful enough, the point is, Confucian economies will never be “open”. Is Japan open now? Are those trade barriers handled by internal networks torn down? Is South Korea an “open” economy? I don’t think so.

    In the minds of Asians, economics is about power struggle from day one. That’s dictated by the culture.

    1. Yves Smith Post author

      That’s fair, and I can just as easily argue this the other way, that it was foolish for the US to embrace/push a textbook idea of open trade, when what we have instead is managed trade.

      The US also, foolishly, has acted as if what is best for US multinationals is best for the US as a country, and that is leading increasingly to corpocracy. Plus, as I have mentioned elsewhere, increased global economic integration (which is what more open trade produces) bumps up against national sovereignity. Unless you are willing to compromise that, you are going to have either increased frictions or increased instability (and Germany’s unwillingness to help with Greece, whether or not that is a good idea, is an example of how nationalism is firmly entrenched)

      1. fromchina

        Exactly, and those views are not changing in the US elite, that’s not what’s driving this yuan revaluation push.

        So I suspect this is all about some Wall Street investments in China wanting to get out with a handsome profit.

        1. lark

          The views of the US elite are to tolerate offshoring American jobs and to disparage industrial policy. There will come a limit though, and I believe we are just about there, when the consequences for unemployment become too severe for even a compromised democracy like our own to accept.

          China is a dictatorship. And do they care about bringing jobs to the country? Of course. Many say it is their primary concern.

          It is only a matter of time – perhaps starting next month – when the elites in the USA begin to view things that way.

          The foolish flopping of Stephen Roach on Bloomberg, where he said Krugman should be squashed with a baseball bat, is only a sign of the discomfort the American elites feel, who have made their fortunes on this imbalanced relationship with China, now that the winds are changing.

          1. fromchina

            I agree there is a limit. But I don’t think we are anywhere near it. Or else we’d be seeing massive protests in American streets everyday.

            What is happening is not, as you say, discomfort by the elite, it is co-criminals bickering over who gets a larger cut of the loot.

            By no means do they feel even remotely threatened at this point.

  17. danny

    Why are a significant proportion of exporters operating under strained margins?

    It appears to me there is a hierarchy of corporations in the export sector of China whereby the upper tier are in a position to skim profits and the lower business operate on low margins. I think that the chinese banking system coupled with government regulations and certain top tier corporations are sustaining these inbalances.

    If profitability was improved economy wide then wages would rise with domestic demand and a rise in the renminbi would be feasible. Higher chinese demand would also help balance the international trade position of China and help offset US trade deficits.

    1. fromchina

      There is indeed a hierarchy of corporations in China. The higher ranked companies are government owned monopolies. They are hugely profitable.

      Most of the companies in the export sector are small private sweat shops. They make the stuff you buy from Walmart.

  18. reskeptical

    This issue along with the Germany/ Euro trash-talk is almost certainly media-hype. How on earth some people can keep a straight face, while comparing a pre-slump Japan to China, is incredible. More a case of wishful thinking/ Freudian projection than economic reality.

    If anything, I’m bearish Germany AND nervous about the USD. Seriously, a Euro depreciation?! I’m on the other side of that bet.

  19. Moshi

    The exit from the PRC dollar trap being (accurately) described in this thread is internationalization of the RMB. That means ASEAN free trade zone, swap lines with key trading partners and direct currency exchange with strategic trade partners (Brazil Russia India). Did I mention this is already done?? China Inc. is buying time to populate the RMB into the trading system. 3%-5% taste to early adopters in 2010, draws more interest. One or two mis-steps by the US, and the option value of a (now) out of the money flight to RMB safety is realized on an accelerated timetable. Sadly, trade/currency war is the rational US response to this dynamic, as outcome is worse at time2. USD look out below. Dollar hegemony is costly.

  20. Crabman

    Since China has much more than a 2% cost advantage over any other manufacturer, Yuan appreciation is more likely to cause Wal-Mart inflation than put Chinese companies out of business.

  21. fresno dan

    If one supposes that China sells low end goods to low end consumers, and that most low end consumers are in real fiancial distress, especially as HELOC is drying up, it seems evident that the exports of China would diminish.
    With the caveat that no one should underestimate American’s love of stuff, one has to wonder if at some point it will be sated, and again, this would lead to diminishing exports from China.

  22. Chris of Stumptown

    It seems to me that the Chinese export model is:

    Imported commodities + Chinese labor = Finished goods

    A strong RMB makes the commodity costs cheaper along with the price of finished goods. To say that inflation will break the back of Chinese exports is too simplistic. The question is not inflation of goods, but the cost of factory labor.

    Additional to side deals, exporters take expertise and produce similar goods for other markets. Even if they lose money, they produce items for sale in Russia, developing Asia, South America, and Africa. I doubt this is factored into Mr. Zhong’s ‘2%’.

  23. spc

    @ ” Too much unemployment would undermine the legitimacy of the governing classes. ”
    As far as i’m concerned the same applies to America.

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