Why we must wait to free-float the renminbi (China)

FT ^

[maui_hawaii]

The discussion about the exchange rate of China's currency is in full swing. Some interest groups of western, mainly American, manufacturers are calling for the Chinese authorities to free-float the renminbi and give up the peg to the US dollar, or at the least revalue their currency by 20, 30 or even 40 per cent in one go. John Snow, the US Treasury secretary, voiced these demands in a recent visit to China.

Fortunately, Beijing has not heeded these calls. A free float or sudden revaluation would be bad for China and bad for business. Instead, Beijing should maintain the peg for now and aim for a gradual revaluation of about 15 per cent over the next five years. Free- floating the renminbi can be considered only when China has a well established financial system. That will take at least another 10 years.

Over the past 15 years, many western companies have made huge investments in China in both production and research and development. For scores of large multinational companies, China is now an integral part of their supply chain and an increasingly important market. A third of Philips' products, for example, are manufactured in China and the country already accounts for 10 per cent of its sales.

In this context, business prefers a stable renminbi-dollar exchange rate. A sudden revaluation of the renminbi would disrupt results for the many multinational companies (Philips included) that supply American and European retail chains with goods made in China. Currently, hedging against exchange rate fluctuations of a free-floating, unpredictable renminbi would be very costly for those companies.

Flexible exchange rates work well for countries with robust financial systems and free flows of capital. With such a system in place, currency fluctuations in the long run tend to reflect the relative economic strength and attractiveness of countries. Despite many improvements, China has a long way to go in this respect. Banks, the bond and equity markets, the tax system, state-owned enterprises and free transfer of money within the country still require a lot of attention. There is no free flow of capital out of China.

Violent, temporary swings in the exchange rate of currencies backed up by well established financial systems are bad enough. Multinational compa nies have not enjoyed the euro-dollar rollercoaster of the past few years. Sudden movements of the renminbi before China has a solid financial system would be disastrous. The resulting uncertainty and speculation would not only hurt companies doing business in and with China; they would also make it harder for China to reform its financial system.

That is in nobody's interest. China is one of the few growth engines of the world economy. Even at the current exchange rate of the renminbi, Chinese imports are growing fast. The Chinese government has three challenging tasks: to maintain the momentum of the Chinese economy; to avoid overheating; and to liberalise. A dramatic change in currency strategy would make that already difficult job almost impossible. If the Chinese economy were to go off the rails, it would not be long before the US and Europe shared the pain.

Those in the US who ask for an immediate free float or a dramatic revaluation of the renminbi seem to think in terms of a zero-sum game. If the renminbi goes up, they reason, there will be fewer jobs in China and so more in the US. The chances are, however, that we would find ourselves in a lose-lose situation. A financial crisis in China could well mean fewer jobs in China, fewer jobs in the US and fewer jobs in Europe.

What is more, to the extent that a rising currency makes China less competitive as an exporter and as a destination for foreign investment, other emerging economies with low wages and high labour productivity, such as Vietnam, would probably benefit more than the west. There is more to the world than China, the US and Europe.

A gradual increase in the value of the renminbi would make much more sense. It would slowly create more room for other emerging economies to become more competitive relative to China. It would also bring the country closer to the exchange rate that its economic strength and labour productivity will warrant once its financial institutions have been strengthened, external capital flows are liberalised and the currency can float freely.

The writer is chief executive of Philips Electronics North America and former chief executive of Philips Electronics East Asia

[RS]

"You are the one arguing for government interferenceinthe free markets please justify that."


Excuse me ? I don't believe governments ( any government ) should interfere with any free market.

About the furthest I would go is to say that a government could add - oh say - 10% duty across the board on every import. This would cover inspections, quality testing of foods, drugs, safety and all that other reasonable govt stuff.

[Malsua]

Shsssh, don't let the cat out of the bag.

I can always tell the poseurs from the informed when people start talking about Yuan. (i.e. Yuan = instant bozo alarm bells).

Anyone who's done business in mainland China knows that the currency is RMB. Or as I affectionately call it "red toilet paper". Once you exchange dollars for RMB, good luck changing it back. I've only found one hotel in Hong Kong that will do it(The Mandarin Oriental). Even the hotel in China I stay at won't give me back my dollars.

I suppose there probably is an official way to getting dollars back, but I've never bothered to figure it out and figured if I ever get stuck in a stall...I've always got some RMB in my wallet to cure the problem. Mao would not be happy.

[lelio]

When (if) they wish to redeem that green piece of paper, it will be to purchase a product that WE have to offer.

They can redeem that piece of paper in China, Germany, or anywhere else in the world. For better or worse, the US dollar is the de facto world currency. It doesn't have to come back here to be spent.

In what way do you think that it gives them any "power" ?

In the old days you could demand to get an amount of gold for your dollar from the US government. So the owner of the dollar had some "power" in that they could get something tangible for it. Right now I'm not sure what China would get if they demanded gold from the US. Maybe an askew look.

Perhaps maui_hawaii knows what China can demand for their dollar horde. I suspect they don't even have the dollars, but instead have electronically traded it for US debt that pays interest.

[lelio]

Once you exchange dollars for RMB, good luck changing it back.

So we're getting little red pieces of paper from them? ;)

Why won't anyone take them? Inflation? Not worth the paper they're printed on?

[RS]

"They can redeem that piece of paper in China, Germany, or anywhere else in the world. For better or worse, the US dollar is the de facto world currency. It doesn't have to come back here to be spent."

Absolutely correct - it can float around out there until inflation wipes it out...


"I suspect they don't even have the dollars, but instead have electronically traded it for US debt that pays interest."

So they get a few more electronic green pieces of paper instead of physical ones... so ?

The crazies - like Saddam - had something like $60 mill in Cash - what good was that doing him, except as support for his own stuff.

I think it's Equador and Panama that are using the US dollar as circulating currency ( there was talk about Argentina using it also ) - In that case we are literally selling them a green piece of paper.

[Malsua]

>>Why won't anyone take them? Inflation? Not worth the paper they're printed on?<<

People will take them for purchases, but Beijing has decreed that foreign currency is not to be circulated inside of the Mainland. You can however often buy things in Shen Zhen with USD, but beyond check point Charlie, it's probably a hanging offense.

The reason I was told "it's not convertible". Shrug. I generally only need about 800RMB for incidentals for a week, so I try not to get more than I'll use.

Oh and I wanted to clarify something slightly...the currency is the Yuan, but that isn't written on it anywhere and people give you quotes and other financial documents with RMB after the numbers. They pronounce it "Remmy B".

[LibertyAndJusticeForAll]

"I affectionately call it "red toilet paper"."

Very good, and, difficult to exchange for greenbacks!
I forget how many tens of millions Mao murdered, but you can bet he's already more than unhappy.

[Malsua]

"but you can bet he's already more than unhappy. "

Well...his picture is on the front of the 100...I would imagine the thought of using it for TP would probably make him even less happy. :)

[A. Pole]

(or worse: China's going to hold a lot of our debt)... and what is so bad about that ? Will they come and take a lien on the Statue of Liberty ?

A great metaphor! This is exactly what they will do, dear Sir.

[RS]

"Will they come and take a lien on the Statue of Liberty ?

A great metaphor! This is exactly what they will do, dear Sir."

Big deal ... she's French anyway - hangs around the harbor waving at sailors :-)

But seriously - unless they want something that we produce, and we are willing to part with it - they have paper.

The Japanese bought up a lot of real estate when they were flush years ago - then sold it back to us at fire sale prices when their economy tanked...

[A. Pole]

But seriously - unless they want something that we produce, and we are willing to part with it - they have paper.

It is not the paper only. They are also getting the American manufacturing.

[maui_hawaii]

You asked a BIG question.

Through the grapevine though...

They are buying up tons of investments in Asia and around the globe. The US only gets a portion of it.

Like I said, this is a very complex question. A whole lot of the money though that spend on Chinese goods never makes it to China. It depends on a whole lot of factors. Like who and what...Its still owned by the CCP, but just in a New York bank account...When they want to buy a port in Singapore they simply do a wire transfer from NY to Singapore and viola. They are piggy backing on our system and relations.

Basically there are two or three major economic 'pushes' that may or may not relate to this specifically.

1) They get money in all sorts of ways to finance large 'development' projects inside of China. Its supposed to create employment in China. (#1 concern in the CCP). More than 2/3 (probably a lot more) of all the cars in China are bought by some form of govt agency. 2)They want to expand their influence around their neighborhood. They bought up investments in Hong Kong (money=power) and are trying to buy in Taiwan. I know they invest in Singapore and Thailand and the Phillippines also.

They snap up these kinds of investments all the time.

They do invest in the US but into what it depends.

They literally are an investor nation...with political intent. The US invests but its the private sector that does it. In China not so. The primary investor is the state.

Keep in mind they will scream and yell about 'the private sector' in China... but in Chinese terms 'private means 50.1% privately owned and 49.9% govt controlled. Truth is the govt is the majority shareholder and they ensure it.

They have started to mix iron grip communist control with private, foreign money.

[maui_hawaii]

Here is a question for the guy...

If China is so competitive, why only source 30% of the products from China?

Secondly a 40% change in currency exchange should equate to a 40% increase in China's ability to consume.

With a correct revaluation the US and Europe, including Phillips should be able to export a whole lot more to China.

These currency prices are relative to the neighbors.

It won't hurt them nearly as bad as they say.

[LibertyAndJusticeForAll]

I expect that Philips believes that after revaluation they will not sell much to Communist China, (or not enough to make up the difference).
You could be correct, but Philips has no motivation to encourage any changes.

[RS]

"It is not the paper only. They are also getting the American manufacturing."

Your'e right ... in a sence we are paying for it in our loss of jobs.
Because of our high labor costs I would suppose that many of the plants would be automated if we continued to make things like VCRs here, so I think that in most cases the jobs would be lost anyway.

[A. Pole]

Your'e right ... in a sence we are paying for it in our loss of jobs. Because of our high labor costs I would suppose that many of the plants would be automated if we continued to make things like VCRs here, so I think that in most cases the jobs would be lost anyway.

And not only jobs are lost. When the manufacturing is moved (automated or not) to get those VCRs, one has to pay or do without.

[RS]

"And not only jobs are lost. When the manufacturing is moved (automated or not) to get those VCRs, one has to pay or do without."

The only problem is that it dosen't seem to work that way -
VCRs are ten times cheaper and much more powerfull then when they were made here.
I really can't think of any product whose manufacture went overseas that jumped in price.

[A. Pole]

I really can't think of any product whose manufacture went overseas that jumped in price.

But it will jump up eventually. If Americans run a huge trade deficit, the free market will correct this by lowering the value of American currency until the moment when Americans will not be able to afford foreign goods.

It happened in Russia at the end of 1990 and it lead to the development of Russian local production. So there is some hope :)

[RS]

"If Americans run a huge trade deficit, the free market will correct this by lowering the value of American currency until the moment when Americans will not be able to afford foreign goods. "

For the last 10 years we are down about 2 Trillion dollars in deficit - what would you consider "huge" ?

I'm not sure how the countries we owe money to would like to have the value of our currency lowered - they would take a big hit on that 2 Trillion that they have in the bank.

Using the VCR example a 50% re-evaluation of the dollar would only lead to $100 VCR's still much better then the $500 when they were made here.

[Last Dakotan]

It has been my experience that the Chinese will buy from us.
They buy entire factories, disassemble them and move them to China. It tends to leave the Americans who lost their jobs feeling real, real fortunate to have the Chinese as customers.

The Chinese (as well as most of the Asian trading nations such as Japan) practice merchantilism. It values trade surpluses above all else and is killing world a trade system that could have benefited everyone.