Yuan revaluation could cause sociopolitical uncertainty

Each one of us has at some point wondered the following. How do the Chinese producers manage to sell t-shirts and watches in far-flung places like Africa and India and Latin America at dirt-cheap prices and still manage to survive and flourish.

An interesting reportage from the South China Morning Post (courtesy Yves Smith) claims that 57 per cent of small-and-medium exporting enterprises in China survive on less than 5 per cent profit margin. This profit margin comes at a time when nominal wages have been rising; and also the rise in real wages and productivity has effectively canceled each other out. In such an environs, the article reports that even a 3-5 per cent increase in the yuan-to-dollar exchange rate will substantively hemorrhage revenues and compound their inability to compete in the international market. Whether this profit margins are true or not, across the board, the importers of Chinese products have increasingly become vocal about their unwillingness to stomach the results of the distorted trade. This has particularly been the case given the unemployment figures that the industrialised nations have at present. For example, one of the larger aggregates of unemployment puts it at around 17 per cent in the US.

Economic theorists, like Stephen Williamson, have argued that blaming the Chinese, or believing that the appreciation of the yuan will solve the US current account deficit, is silly and hypocritical.

He argues that the US is no different. It provides direct and indirect subsidies/sops to their exporters and in many directly intervenes in negotiations on behalf of its firms. Be that as it may, the allegations of currency fixing against the Chinese pose larger questions than any particular tariff-rigging in any particular industry that the Americans' might be accused of. Given the seeming inevitability of some brass-knuckled restrictive trade regimens to be put in place against Chinese exporters in the United States — the only meaningful question to ask is how will it come about, and what are the likely consequences.

Like any complex question — there is a short answer and a long answer. The short answer is nobody knows. The longer answer is that while we may not the exact sequence of events, we can try to draw out the larger contours of this debate.

Transfer of wealth

Within China, a revaluation (decrease in the price of the dollar in renminbi/yuan terms) results in a transfer of wealth. As the domestic currency appreciates, income rises (relatively) amongst the importers (which tend to be households) and away from businesses that rely on exports. The real question, as Michael Pettis argues, is what the optimal speed of revaluation. If the revaluation happens all too fast, the import sector will suffer losses, default on credit payments shall rise and subsequently push unemployment numbers up. Inescapably, the issue of social cohesion and political stability arises.

The resultant sociopolitical uncertainty is partly the reason why the new generation of Chinese leadership, who are to take over in the coming months, are increasedly pushing back to assorted exhortations by the United States and others.

But, in a recent op-ed in the Wall Street Journal, Professor Yiping Huang of the influential Peking University hinted at the fall back recourse the Chinese have in mind — capital account controls. The result of this would be that there wouldn't be enough yuans to buy for the freely available dollar — and the Chinese might just be able to stave off any pressures.

There is much talk on both sides, by many an eminence grise of the public policy world, about the need for structural reforms. These include addressing the unprecedently low interest rates in China or historically low savings rate in the US etc. While these are useful goals — structural reforms require the ability and willingness to expend political capital. And at present, there isn't much to spend in Beijing or Washington.

The columnist works for a major European investment bank in New York City. You can follow his tweets at http://twitter.com/ks1729