Originally created 06/13/05

Revalued Chinese currency could boost U.S. inflation



NEW YORK - Sometimes you must be careful what you wish for. That may end up being the case with the United States' push to get China to revalue its currency.

Should the yuan become a free-floating currency rather than trade at a fixed exchange rate, it could be a boon to U.S. manufacturers that have struggled to compete with the cheaper goods produced in China today.

But that doesn't take into account some of the unintended economic consequences of a higher-priced yuan - namely how it could boost U.S. inflationary pressures by raising the price of everything from electronics to T-shirts and cause all kinds of problems for companies like Wal-Mart Stores Inc. that source merchandise and materials from China.

The yuan has been pegged at 8.28 to the U.S. dollar for a decade, and critics charge that fixed rate undervalues the yuan by as much as 40 percent, which in turn is giving China an unfair trade advantage. They point to China's contribution to the record high $617 billion U.S. trade deficit last year, which included a $162 billion imbalance with China alone - the largest ever with a single country.

The Bush administration has been prodding China to stop linking the yuan to the dollar and instead move to a more flexible currency system. That push intensified in recent months, following a Senate vote in which lawmakers expressed preliminary support for a bill that would impose 27.5 percent across-the-board tariffs on Chinese products if China did not alter its currency policies.

Such tactics have been lauded by groups that want the yuan revalued. The biggest support comes from manufacturers including those in the auto, textile and heavy equipment businesses. They contend China's currency system is hurting U.S. exports by making Chinese goods cheaper in the United States and American products more expensive in China and contributing to job losses at U.S. factories.

A yuan revaluation would also help any company that sells goods into Asia, derives a lot of its revenues from Asia, or has its costs dominated in currencies that would be weaker than the yuan, like the dollar. Among the winners would be luxury goods companies that have their costs based in dollars but collect revenues in more expensive currencies.

But benefits won't be all around - especially for U.S. consumers and many businesses.

Federal Reserve Chairman Alan Greenspan pointed out last month that letting the yuan move higher against the dollar would increase prices American shoppers pay for Chinese goods. "The effect will be a rise in domestic price in the United States," he said, in comments made after a speech delivered to the Economic Club of New York.

Similar thoughts came from Wal-Mart senior vice president Charles Holley, who said during an investment conference in late April that the world's largest retailer was looking to "locate alternative sources" if cost increases appear.

"If those costs go up, there is a chance that that may translate into a higher price," he said, according to a transcript provided by Thomson Financial's StreetEvents.

A higher yuan could also boost operating costs at the many companies that use Chinese components to run their factories.

"All those cheap goods that the Chinese are selling us improve our standards of living," said Oak Associates chief economist Edward Yardeni. "The Chinese have helped to put a lid on our inflation rate, contributing to the rise in our inflation-adjusted wages and salaries."

China is also one of the leading buyers of U.S. Treasury securities, which has helped keep U.S. interest rates down. Should the Chinese pull back on that spending, it could lead to higher borrowing costs - something that could potentially cool the housing market.

It's too soon to know whether China will take any action to revalue the yuan. So far, officials there have been cool to the idea.

As Morgan Stanley's Asia-Pacific economist Andy Xie points out in a recent note to clients, China could be more apt to pay the steep tariffs on goods heading into the United States than agree to a big revaluation.

And since American and other foreign companies generate four-fifths of China's exports to the United States, they would end up bearing the brunt of any tariff imposed. Xie estimates that could costs U.S. businesses $50 billion.

"Their impact on corporate earnings could be so severe that the stock market could fall sharply," he said. "I don't think that the U.S. government would act to allow something like this."

Maybe the only certain thing is that U.S. companies are closely watching this situation, and are already making plans to combat potential troubles ahead.