Five Ways the Chinese Exchange Rate Directly Affects You

By Karin Hernandez - September 25, 2012 | Tickers: AAPL, WMT | 0 Comments

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There is no debate about the fact that the Chinese government regularly intervenes in world currency markets to keep the Chinese currency, the yuan, deliberately weak against the U.S. dollar. The United States has been complaining about this fact for years, and the Chinese government has agreed, stating that they intend to slowly and steadily strengthen the yuan against the United States dollar, in measured increments.

This strengthening has occurred over the past few years, and the Chinese central bank has increased the yuan approximately 7% during that time. However, this past spring, the Chinese again began to depreciate their currency.   Although the Americans may protest that this is deceitful and unfair, the reasons for this are simple: The Chinese economy has slowed significantly from its previous pace, due to a rapidly deflating real estate bubble, declining foreign investment (due to concerns of a weaker economy, a vicious cycle), and weak retail sales.

With the Chinese central bank targeting a lower exchange rate, they can prop up their own flagging economy and stimulate domestic sales, albeit at the expense of other nations.

What does this mean to you, the average American consumer, in terms of your pocketbook and your life?

1. The weak yuan/strong US dollar combination makes “Made in China” products on American shelves less expensive. If the Chinese government allows the yuan to increase by 10%, that will mean a direct increase in the costs of everyday products. This would be an unacceptedly high burden for millions of low and middle-class Americans, as well as millions of American companies who buy cheap Chinese imports.

2. The weak yuan/strong dollar makes “Made in America” products on Chinese shelves more expensive. This weakens demand in China for American products, by encouraging the Chinese to purchase their own products, and stunts the growth of U.S. exports to China. This can have negative effects on employment in industries that export products to China, such as the food industry (especially soybeans), airplanes, scrap metals, fertilizer and chemicals, and pharmaceuticals

3. A weak yuan followed by a surge in Chinese exports, while good for the Chinese economy in the short run, may act as a long-term catastrophe for other developing nations during this period of global weakening, by driving demand to China. At the extreme, this could result in many developing countries exiting certain businesses, leaving China as the major or sole exporter.

4. China has also been recently shifting to higher-technology exports, which could begin to displace workers from the U.S., Europe and Japan.  Such a fear is clearly not unfounded, as this is exactly what happened with industrial production.

5. Because of the trade imbalance, the Chinese buy U.S. Treasury Bills with their excess dollars. This huge purchasing activity keeps the demand for Treasury Bills high, which keeps the price high, which keeps interest rates low. Thus interest rates are perhaps lower than they would otherwise be without the Chinese purchases. For borrowers, this is good; for lenders, not so good.

A recent report from Pew Research shows that most Americans want the U.S. government to “get tough on China regarding economic issues.”  The general public also tends to view China as either competitor or enemy. On the other hand, the experts surveyed (business, military, government and scholars) all felt that China was less of a threat than the people believe.

The issues involved with currency markets are many and complicated. The obvious solution from an American point-of-view – just “make” the Chinese increase their currency and play fair – is not as simple as it seems.

Such tough negotiation could touch off a new trade war, in which both countries would likely lose.  An increase in protectionist policies tends to reduce costs for domestic manufacturers at the expense of domestic consumers. In other words, U.S. manufacturing companies would likely benefit, but U.S. consumers would probably lose.

One major company that benefits greatly from the fact that Chinese imports are inexpensive compared to U.S.-made products is Wal-Mart (NYSE: WMT). Love it or hate it, the company is so inextricably tied with China that untangling it would be a global nightmare.

In 2010, Wal-Mart accounted for approximately 15% of the U.S. total imports from China. Their imports totaled $30 billion, and Chinese-made products accounted for approximately 80% of Wal-Mart’s annual imports.

Reports have estimated that Wal-Mart is responsible for approximately 200,000 American job losses in the period 2001 – 2006, due solely to their importation of Chinese-made products. Approximately 66% of those were manufacturing jobs, the kind that offer higher wages to the less-well-educated. Politicians and anti-Chinese voices seize on those numbers as proof that Wal-Mart and its imports are bad for America.

But consider that Wal-Mart is not deliberately working to undermine the American economy. They are not setting out to destroy U.S.jobs, but are acting rationally to provide the lowest-cost products that they can obtain for their poor and middle-class consumers. In large parts of the country, Wal-Mart is the largest employer and, ironically enough, those employees then spend much of their paychecks at Wal-Mart. A 5 to 10% increase in the yuan would likely see that passed directly along to consumers, in the form of a direct increase in prices on the shelves.

Consider also, the vast amount of good that has been accomplished in China, in terms of lifting their people out of grinding poverty and moving some of them into the emerging middle class. Wal-Mart has over 20,000 Chinese suppliers, who employ millions of workers. It has been estimated that Wal-Mart has contributed to the creation of 10 million jobs in China, adds $15 billion to China’s GDP annually, and thus is responsible for helping 32 million people live above the poverty line.

Another company that reaps a great deal of benefit from the low Chinese worker wages is Apple (NASDAQ: AAPL). Of the retail price of a new iPhone, over 50% goes to the retailer and to Apple. Only 2% is spent on wages for the 230,000 Chinese assemblers employed in Shenzen by Taiwanese company Foxconn. Like Apple, many technological innovators design and market their products here in the United States, but most of the assembly is done overseas.

Interestingly enough, the Federal Reserve in San Francisco conducted a study during the summer of 2011 that reported on the actual versus perceived value of goods made in China, and the results are somewhat stunning. In fact, only 2.7% of total U.S. consumer spending in 2010 was spent on goods that were made in China. The highest percentage of made-in-China products fell into the Apparel/Shoes category, where Americans purchased 36% from China, versus 25% of Apparel/Shoes made in the USA.

One surprising company that exports autos made in the United States (South Carolina) is BMW, which actually exports more vehicles made in the U.S. to China than any of the American auto companies. The Spartanville plant employs over 7,000 workers and builds 300,000 vehicles a year, of which 70% are exported to foreign contries, and 60,000 go to be sold in China. The company is actually planning to increase production by 2014 to 350,000 units per year, and will be hiring additional employees. BMW was just recognized by the National Association of Foreign Trade Zones as Exporter of the Year and received the Export Achievement Award for being the member that showed the most improvement in value.

China has just instituted a tariff on large cars and SUVs, accusing the U.S. of dumping and improper government subsidies (sound familiar?). Likely this pain will fall harder on BMW, which exports the X3 compact SUV, than on Ford, GM or Chrysler. 

And as a final thought, how do you think the Chinese, the Germans and the Japanese people view our own Ben Bernanke and his QE1 and QE2? They think it’s currency manipulation, plain and simple. The exact same thing that we are accusing the Chinese of doing.

There is both good and bad to the Chinese yuan being undervalued, and the situation is far from black and white. So the next time you hear someone discussing the unfairness of the Chinese currency exchange rate, be sure to take all sides of the debate into consideration before you draw your own conclusions about what you think might be best for America.

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