China Revaluates Yuan – Let the Scenario Planning Begin
By George Anderson
China’s decision last week to peg the value of the yuan to a number of foreign currencies and not simply the U.S. dollar has generated a lot of speculation on what it will mean for various sectors of the U.S. and world economy.
With approximately 14 percent of total U.S. imports coming from China, any action that could increase the prices of goods coming from that country is a concern for businesses that buy and resell those goods to American customers.
Most economists and monetary experts, however, seem to think the revaluation rate will have little or no impact, at least for the short term, on the prices paid by consumers in this part of the world.
Huo Jianguo, described as a foreign trade official with China’s Ministry of Commerce (MoC), does not expect to see any negative impact on the country’s ability to export goods unless the yuan’s revaluation rate goes above five percent against the U.S. dollar. The current revaluation rate put it as two percent against the dollar.
If anything, the country’s decision to revaluate the yuan may bring it more American dollars as it addresses, albeit in a small way, the call by some in political and business circles to restrict the access of Chinese goods to American markets.
Mr. Huo said his country and the U.S. will soon resume trade talks over the export of textiles and paper to the American market.
Moderator’s Comment: Putting yourself in the position of an American retailer doing scenario planning, what do you see as the potential longer-term consequences
of the decision to revaluate the yuan and the actions your business might have to take in response?
– George Anderson – Moderator
My experience has been that the “real” value of the yuan against the dollar has already been incorporated, in some part, into the costs of goods manufactured in China using imported raw materials or components. We’ve seen prices for those products rise disproportionately to the commodity index they’d be most linked to.
Overall, large importers, be they retailers or manufacturers, can begin to hedge currency risk by buying futures contracts on yuan. Most sophisticated importing companies have done this, and if the yuan appears to be headed for devaluing, there are ways to manage around that.
I disagree with the writer who said that price increases help retailers because inflation impacts the value of inventory…..this is just weird. Higher cost of goods results in one of two outcomes. Either the retailer experiences margin erosion, or they raise the retail price. If the retail price is raised, all of the uncertainty around value, elasticity, and competitive response come into play. Products are retail priced based on the expected consumer value perception. Hi-lo, everyday low, periodic promotional – the price play doesn’t really matter. Every retailer decides what the average out-the-door selling price the market will bear is. The cost should not, and in good companies does not, drive the retail.
If Chinese products inflate in cost, and no other source is found at a similar cost, the inflated goods will either be re-priced, or de-emphasized. The impact may be that the offerings provided at opening price points carry less perceived value than in the past. Or that there is less assortment breadth in any price point niche supplied primarily by Chinese goods.
But since we really don’t know what the yuan is going to do, this is really just blog speculation.
The cost of Chinese imports is of little real consequence to our economy. Most Chinese products coming into the USA are not the result of the Chinese pushing them down our throats; they are the result of former US manufacturers trying to stay in business in the face of international competition. Our corporations are sponsoring Chinese manufacturing to procure products to keep the American consumer happy. China’s manufacturing efficiencies will increase enough to offset any currency issues and their exports to the USA won’t slow down one bit. HOWEVER…!
The real story is not that the Chinese floated the Yuan. What is important here is that they did not float it against the dollar alone but against a basket of currencies (Euro, yen, Pound, etc.).
This is a profound statement and indicates that, internationally, the dollar is NO LONGER the standard! International trade depends on a stable means of exchange and China’s action reflects their opinion that the dollar is no longer that stable means of exchange. Look for oil, airfares, and other international products and services to move away from an unstable dollar to other currencies (Swiss franc) or even gold. Our currency has been utilized as “The Standard” ever since the close of World War II. It has been backed ONLY by the confidence of the world in our nation and our systems. This confidence has eroded to the point that China is no longer willing to tie their means of international exchange to the USA. This is a vote of NO CONFIDENCE of immense scale and will have far reaching effects for our economy and our influence around the world.
At the risk of sounding naive and/or paranoid, it seems that pegging the yuan to multiple currencies will enable the Chinese to encourage competition amongst its international customers. It will also enable them to maximise the value of their export sales. The logical conclusion I draw from this is that yes, prices will go up for those importing goods from China.
There has been a lot of coverage recently about the companies and brands being purchased by the Chinese. They have also been welcoming foreign investment and Western ways of spending the money they earn through their export trade. Although the government and the way they govern may still be Communist, economically they seem to be pursuing capitalism at a rate of knots. It will be fascinating to see who actually benefits over the next few years.
Bacon and eggs represents involvement for chickens and commitment by hogs. Some U.S. retailers are committed to Chinese imports at any cost because they’ve invested in production, distribution, and transportation facilities there, and are no longer just “involved.” Wal-Mart and Dollar Stores come to mind.
To answer one of Gene Hoffman’s questions, the yuan immediately gained against the dollar and is predicted to hold those gains. Immediately, the cost of imports from China grew. (Hooray for American labor!)
China is set on emerging as a beloved, nee respected, world power, and has focused on their hosting of the 2008 Summer Olympic Games for that emergence. This change in currency valuation is simply a part of their grand plan, like McDonald’s emphasis on salads.
However, the Olympic spotlight will also expose China’s human rights abuses and how they’ve built the facade of a progressive nation on the backs of their people. Theirs remains an oppressive regime that will never enjoy the true benefits of capitalism. You can only fake capitalism for so long, and then Les Miserables happens.
When Japan began manufacturing and exporting inexpensive transistor radios to this country in the 50s, they created a market for an unknown product. China recently created a market here for junky little plastic crap that has no real value but somehow captures our attention. Their follow-up to that market penetration will be telling, and I am confident that it will tell a story that’s not compatible with the values of this country.
My assumptions would be:
a. Retailers will try to source merchandise from the “lowest cost for the desired quality” places. China is not the only low-wage nation.
b. Higher wholesale prices, if non-Chinese sources are not less expensive, will help retailers. Retailers carry inventories, and if these inventories are subject to inflation, it’s profitable, since all retailers will have the same issue.
The alternative is deflation, and deflation hurts retailing profits, in my opinion, since the inventory is less valuable every day.
Is the yuan revaluation a commercial or political decision? Does anyone really know what the revaluation of the yuan truly will mean to American retailers? If the yuan gets more valuable, the merchandise from China would cost more. That could possibly open windows of opportunity for manufacturers in other countries, including the U.S., and retailers will respond.
The American retailer will continue to look for the best combination of quality, “fashion” and price for his/her assortments and thus most of the “spoils” go to the country that supplies that combination best. China is astute. They don’t plan to lose control of the paradigm that allowed them to capture 14% of the exports into America nor do they want to jeopardize the growing export role they are achieving throughout the world.
It appears to be rather ironic that the majority of economists are predicting a rise in prices of imported goods. These are the folks that are supposed to be politically knowledgeable, as well.
I would like to suggest that economists inject in their economic models the formula of “C to the third power” = COMMUNISTS.
China is a communist society. They are still Leninists. Although we enjoy the illusion that China is a democratic economic state, the entire economy, including the black market and secondary market, is managed by the Communist Party members.
I would like to offer the proposition that China leadership actually see this as an opportunity to use their currency surplus to a significant benefit.
They will strengthen the Chinese currency in short spikes to purchase foreign assets at a diluted cost, but, in the long run, they will allow the Chinese currency devalue to ensure they are the dominate exporter.
We will see a momentary spike in costs of imports from China driven by the investment bankers and currency traders in Hong Kong and New York, not by the Chinese. Once the investment bankers and currency traders extract their gains from the manipulation of currency, everything influencing the value of Chinese currency will revert to the Communist Party.
By the way, don’t look for price increases at US retailers this Christmas season attributed to any action by the Chinese. The Chinese were very skillful to wait until all the Letters of Credit and all the orders for merchandise were in-house for 2005 Christmas before they did anything.
You want to worry about Asia? Worry about the Chinese and South Koreans who are buying US Mortgage backed securities as though they are cups of coffee at Starbucks. The moment they stop buying up mortgage backed securities, mortgage interest rates will rise as fast as an elevator at Trump Tower.
I worry more about that; more than I do currency.
The obvious answer for retailers regarding the revaluation of the Yuan is that imports and Chinese investment are going to get more expensive. Conversely, the Chinese consumer is going to be able to afford more imports and Chinese investors are going to see the cost of US investment decline.
The really scary thing about this whole thing is “How well the Chinese are teaching us capitalism.” Here is a nation that has kept the value of their currency low, encouraging exports, and bringing their economy to a high level of utilization. Now that they have us “hooked” on cheap goods and are ready to make foreign investments, they begin to raise the value of their currency so that foreign investments are cheaper. It appears both Unocal and Maytag are going other ways right now, but I am sure there will come a time when the revaluation pays off.
Will the “real capitalists” please stand up?