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

[Eric Paul]

The characters next to Mao's head say the amount and Yuan. Nowhere on the note does it say Renminbi. On the back side it does say Zhounguo Renmin Yinhang but this is not the name of the currency either it is the name of the bank, China's People's Bank. Finally if you are interested in changing your notes back to dollars while in Beijing you can easily do it at the Holiday Inn Lido, I doubt this is the only hotel you can do it at but have not checked any others as I like to stay there.

[batter]

Thanks for the bump.
I'll be the first to admit that I don't have a great knowledge of the currency markets but got an idea from some of my university econ and business classes. RS would scare me as an importer. Evidently s/he doesn't seem to know how important currency exchange rates are to the cost of products...I don't think RS was being overly beligerant to you but they seemed unwilling to try to understand your point regarding the currency. RS is totally focused short-term ability of their product to make money, rather than the long-term ability of their product to make money without the high overhead of constantly switching suppliers (to maintain the low labor costs etc) or the potential of a manipulated market to burst....something it seems many manufacturers are doing. Worse, this could come back to bite investors. When it does, it will be interesting to see who is blamed; there have been plenty of news reports with warnings regarding China's artificially inflated markets and dubious banking 'industry' (which may need yet another bailout).
Let me know if I'm way off on what I've just posted, but that is how things currently appear to me.