What is the real value of yuan?

By Siva Yam,Phil Wong (China Daily)
Updated: 2010-10-29 14:04
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A lot has changed since the day that King George III sent an envoy to congratulate Emperor Qianlong on his 80th birthday. It marked the beginning of a formal East-West diplomatic relationship, although King George’s real agenda was trade and permission for missionaries to preach Christianity in China.

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Misunderstanding and disparity, however, remain unchanged to this day.

What is the real value of yuan?
Siva Yam, managing director of Siva Yam & Associates and president of the US-China Chamber of Commerce.

Three hundred years ago, European vessels sailed to China with a light load and returned with hundreds of thousands of pounds of tea, porcelain, silk and other Chinese products. Today, ocean tankers from the United States sail to China and return full of toys, home appliances, consumer electronics and furniture.

The trade gap between China and the US has skyrocketed to $145 billion in the first seven months of this year and along with its trade surplus, China has accumulated a huge foreign reserve of $2.7 trillion.

Such a disparity compounded with a high unemployment rate in the US — in particular, in the manufacturing sector — has plunged global economic cooperation in disarray. A currency war is imminent.

In a recent International Monetary Fund meeting, the US stepped up its warnings that manipulated exchange rates by China were standing in the way of global recovery, while Beijing said an extremely loose monetary policy in the advanced world — namely the US — was creating destabilizing capital flows.

Is the renminbi undervalued? Is it the cause of trade imbalance? Is China the scapegoat for unemployment in the US?

From a historical and cultural perspective, companies in the US have not focused on exports. The US is the largest consumer market in the world, and companies in the US have been too busy in serving their domestic customers. Accordingly, the US perennially had a trade deficit even before China emerged an economic power. For the US to close the trade gap with China, companies in the US must find something that the Chinese wants. But what can the US sell to China? The answer is technology.

The US’ biggest advantages are technology and management — things that the US should export to China.

Unfortunately, the US is not doing very well in this regard because of national security concern and fears that its technologies will be stolen by China. The US has a huge advantage in the cultural and entertainment sector. If China fully opens its cultural and agricultural sectors, the US would have fewer complaints.

Although the currency exchange rate might play a role in China’s enormous trade surplus, the main factor is China’s excess production capacity. Its competitive position is further enhanced by an aggressive investment campaign in its infrastructure.

While the twin engines driving the Chinese economy are exports and investments, the safest and quickest way for the Chinese to get rich is to invest in real estate. Many factory owners are de facto real estate investors, and factories are simply veils for their real estate activities. This leads to uncontrolled investments and excess capacities.

Along the way, Chinese manufacturers have become efficient because of extensive investments in capital goods. Excess capacities, coupled with the urgency to keep 1.4 billion people employed and various aggressive government policies account for Chinese products’ low prices.

China’s exports to the US are usually low-value-added products. US manufacturers cannot and should not compete with these low-value-added importers.

Resources should be allocated to high-value-added sectors such as information technology, healthcare, and research and development.

Even if the US did not import goods from China, it would still be importing from other countries.

Further, Chinese companies are not doing most of the exporting. Importing to the US is actually originated mostly by companies in the US. Thus, the situation is not one of the Chinese selling products to the US but one of the Americans doing so.

The exchange rate may be a factor in the trade imbalance, but it is not the key factor. Whether in the end the renminbi is undervalued, it is difficult to judge. No one knows how much the renminbi should be worth.

China’s foreign reserve in US dollars has been a big headache for China. To keep the dollar from falling too low, China must continue to buy US bonds. China is lending to the US and selling cheap goods to American consumers.

This allows the US to have minimal inflation and maintain low interest rates. China’s consumer market is not mature so it must rely on exports, while the US, which has the most mature consumer market in the world, is China’s largest export market.

One day, when China’s domestic consumption reaches a certain level, exports to the US will no longer be so important. At that time, China will not need to purchase dollar assets to keep the dollar stable and maintain the value of its reserves.

Sino-US relations is the world’s most important bilateral relationship. Both countries must strive to understand each other’s needs and the restraints under which the other is operating.

American companies need to focus on higher-value-added sectors and the US government needs to encourage more investments in R&D and capital goods. China needs to be more transparent; more diligent in enforcing intellectual property rights; and more willing to further open up its culture, sports, entertainment, and financial services for US export. Most importantly, China needs to better allocate its resources to reduce excess capacities in low-valued-added manufacturing.

In the end, consumers will determine US-China trade relations. Meanwhile, misunderstanding and disparity will continue.

Siva Yam, CPA, CFA, is the managing director of Siva Yam & Associates, a private consulting and investment banking firm that specializes in business and trade activities between the US and Asia. He serves as president of the US-China Chamber of Commerce.

Phil Wong is a practicing attorney in Chicago. He also serves as an editor of the US-China Chamber of Commerce newsletter.