China’s Currency Manipulation- Excuse or Trade Disrupter

China condemned the U.S. on Wednesday October 12, 2011 after the Senate passed the “Currency Exchange Rate Oversight Act,” with a 63-35 majority that threatens to punish China for allegedly undervaluing its currency with retaliatory tariffs on imports from China. Although the legislation refers to countries, it is clearly designed with China as its primary target. In effect the bill would require the US Treasury Department to determine if China is manipulating the yuan. If this is deemed to be the case, extra tariffs could be placed on some goods the US imports from Chinese suppliers. According to Chinese Foreign Ministry spokesman Ma Zhaoxu, the bill is essentially trade protectionism, a serious violation of the World Trade Organization rules. For some years U.S. Congress members have threatened to take action on Chinese imports to retaliate against what they see as China’s manipulation of its currency valuation. They state that the undervalued currency enables China to have a large trade surplus vis-à-vis the U.S and that this has caused the loss of American jobs. These charges have been refuted by the Chinese government, arguing that the US trade deficit and unemployment are due to domestic factors in the U.S. and not Chinese policy. This has been a central economic policy issue between the two countries and the passage of the Senate bill has heightened US-China tensions and raised the potential of a serious trade war. The People’s Bank of China said that blaming China’s “undervalued” currency will not solve US domestic problems such as high unemployment, huge trade deficits, or low level of savings, nor will it reduce trade imbalances between the two countries. The People’s Bank of China also stated that this will affect China’s ongoing foreign exchange reform, and China will continue to promote reform of the exchange regime and thus increase the yuan’s flexibility.

As stated in the China Daily, if the world’s largest economy wants to seek a lasting solution to its stubbornly high unemployment, which is an effect rather than a cause of its various domestic troubles, US politicians should stop promoting protectionism. They should recognize that international trade and investment have been and remain major drivers of productivity, innovation and employment, especially in this era of globalization. If an all-out trade war breaks out because the US uses the bill to press China to let its currency appreciate and China responds with countermeasures, they would not be the only two countries who suffer, but the after-effects could be felt world-wide.

The move is seen to have seriously violated international trade regulations and sent the wrong signal in escalating trade protectionism, said Shen Danyang, spokesperson for the China’s Ministry of Commerce. At this critical moment, the U.S. Senate has disrupted the world’s joint efforts to prop up global economic recovery and curb trade protectionism by using domestic legislation to threaten to punish China for its so called currency manipulation, said Shen.

Shen Danyang also said that it is believed within China that the two countries should promote bilateral trade cooperation through dialogues and positive measures. Although most analysts see a slim chance of the bill becoming law, some do believe that China could retaliate for instance by taxing US multinationals in China. Huang Yiping, chief economist of Asia Barclays Capital stated in a research note that it is “an untimely move given that the US and China need to work together to prevent another financial crisis and global recession.”

The bill will have to clear the House of Representatives and be signed by President Barack Obama to become law so for now the vote will have little to no direct impact on foreign businesses in China, although obviously it will not improve an already difficult business environment. For U.S. businesses, it is unlikely to lead to more latitude on matters such as indigenous innovation, technology transfer, IP protection, government procurement and bureaucracy.

For just over a year, the yuan has been allowed to appreciate at a rate of about 0.5% a month, or 6% a year. It’s possible this may temporarily accelerate during the coming months. What does this mean? In a nut shell the companies that are budgeting in U.S. dollars, may find China to become a little more expensive than before. If we sum China’s rising labor costs this could result in the need to look for efficiencies, better productivity or other improvements elsewhere if margins are not squeezed, otherwise exports will suffer as countries slow down their importation from Chinese manufacturers

For Chinese manufacturers, this will result in exports becoming more challenging despite imported raw materials, overseas investments and acquisitions becoming more affordable. The bill has not been passed as law yet, and so immediate actions are still not needed. Experts do advise MNCs to stay alert for the Chinese government’s next move. A long-term solution could be considering diversifying sourcing of goods to other countries besides China, such as Vietnam, Cambodia etc. Companies looking to invest in China should take a look at the hinterland (so away from the eastern, coastal provinces) where labor costs are lower and infrastructure is still solid thanks to government infrastructure investment.

China’s Ministry of Commerce on Wednesday expressed its adamant opposition to the vote the U.S. Senate passed and hopes the U.S. will deeply contemplate the issue and take an objective and rational view on the yuan exchange before making further decisions.