China's baby step unlikely to leave big footprint on U.S. economy

July 24, 2005|By Jay Hancock

THE DIGITAL PRINTER-copier-scanner, made by Lexmark in China for export to the United States, was going for $59.96 at Circuit City last week.

China's move on Thursday to strengthen its currency, which Treasury Secretary John W. Snow said "will be a significant contribution toward global financial stability" when phased in, would raise the device's price, assuming the cost is passed along, to $61.16.

That's a 2 percent difference - $1.20. Kind of puts all the hullabaloo in perspective, doesn't it?

"It's a baby step," says Mark Vitner, senior economist for Wachovia Corp. "It's probably not going to mean that much in the way of prices."

Or anything else in the economy, for that matter.

Theoretically, an increase in the value of China's yuan against the dollar would cut the U.S. trade deficit and ease pressure on American workers from inexpensive imports.

That's why American politicians have badgered Beijing for years to unfasten the yuan-dollar link, which they said was too low and made Chinese goods artificially cheap on world markets.

Last week China seemed to comply, nudging up the exchange rate, harnessing the yuan to a basket of currencies instead of just the dollar and promising to let it fluctuate accordingly.

But the more likely result is business as usual - except with a couple extra after-dinner toasts when Chinese President Hu Jintao visits President Bush in September.

China hopes the change "will be enough to get the political hacks in the United States off their back and allow them to continue to de facto run a very strong link with the dollar," says Steve Hanke, a currency expert and professor of applied economics at the Johns Hopkins University. "They might continue to do exactly what they've been doing."

Unlike the euro, Japanese yen and other major currencies, the yuan's value is set not by freely acting traders on foreign exchange markets but by financial authorities in its home country.

For more than a decade, Beijing has fixed the yuan's value at 8.28 to the dollar. It made the peg stick by buying Treasury notes and other dollar-denominated securities with the billions that U.S. consumers spend on Chinese goods each year.

At that rate Chinese manufacturers have been able to undersell global competitors, especially in the United States, where Chinese imports have contributed to losses in factory jobs as well as the bargains we've come to expect at Wal-Mart and other retailers.

The new exchange rate starts at 8.11 yuan to the dollar. At 2 percent that's a much smaller change than the 5 percent adjustment some analysts expected.

And it's infinitesimal against the 40 percent adjustment some critics said was necessary to bring the yuan up to its "natural" value and create a level playing field in international trade.

"I wouldn't put a lot of hope that we're going to see a big impact on the trade gap, at least not in the near term, from this move," said Alan Levenson, chief economist at T. Rowe Price.

And maybe not even in the longer term.

Along with the 2 percent bump, Beijing says it will let the yuan move 0.3 percentage points daily in accord with an index of foreign currencies. Each day's closing price will be the midpoint of the next day's allowed range, meaning the yuan's value could change significantly over time.

But Hanke says that the basket of currencies in the index will be secret and that behind the shroud China could continue to effectively peg the yuan at a low rate against the dollar, even as it defuses the political liabilities of doing so.

Beijing said the new system is "flexible."

"That was a code word for something that now is going to be completely opaque. No one will have a clue about what they are doing," Hanke said. "Maybe the dollar will be the only thing the Chinese have in the basket."

After all, why mess with something that worked so well for a decade? Beijing's currency regime has supported the rise of hundreds of millions from poverty to middle class, shielded China from Asia's 1997-1998 financial crisis and allowed Hu's Communists to exercise supreme and uninterrupted power.

Beijing acutely knows the danger of moving too quickly from a Communist economy to free-market one. It's on display next door, in Russia, the sick man of Asia. China also knows and fears currency blowups; a sudden currency appreciation in the 1930s helped stoke the unrest that brought Mao Tse-tung's Communists to power, Hanke said.

Americans who want substantial change tried to be optimistic that last week's yuan budge is the start of something bigger.

"To paraphrase the Chinese philosophers, the trip of a thousand miles can well begin with the first baby step," New York Democratic Sen. Charles Schumer told Washington reporters last week.

Yeah, but so can a walk around the block.

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