China's Changing Currency Policy: Something to Fear?

Sourcing professionals looking to China can no longer take low costs for granted


By Josh Green

China's currency is rich fodder for a tangled debate that's making players on both sides — East and West — skittish. At stake are potentially rising costs on goods bound for America and an increasingly tenuous marriage between the world's superpower and its largest creditor.

So what's going on in the rocky global-economic sandbox? Is China playing fair? Is the US being bossy? And what are the implications for those who stand to lose customers, profits or both?

America's blissful trade relationship with China — where cheap labor, low costs and a stable currency have been the norm — is souring. Coming between them are soaring wages, intense foreign pressure to strengthen the yuan and a looming trade war.

While this is not great news for China-dependent sourcing executives and suppliers, it's not the end of the world either. With some careful planning, resourcefulness and creativity, sourcing professionals and suppliers can help each other survive — and thrive — in a new era.

But first, let's take a look at how we got to where we are today.

A Brief History of the Yuan

For years, the yuan's exchange rate was pegged to the dollar instead of floating freely like other currencies. Prior to 2005, the rate was a consistent 8.35 to the dollar — but in 2005, the Chinese government allowed the yuan to budge a little. By 2008, it reached a new high — 6.8 to the dollar — where it remains (more or less) today.

When the world plunged into economic crisis a couple years ago, China kept its head above water while other nations — including the US — floundered. Still recuperating, these countries are watching as China is poised to become the world's second-largest economy this year — and they scapegoat an undervalued yuan as a reason for China's fiscal fitness and their own sluggish recoveries.

Now American and other governments are putting renewed pressure on China to unshackle the yuan, let it gain strength and, ultimately, permit it to float freely. Such a move, they say, would boost the cost of Chinese exports and open the door to healthier competition.

The Politics of Currency Change

Many in US political circles believe that China undervalues its currency in order to boost exports, quash competition and undermine American jobs.

While the Treasury Department postponed its decision to label China a "currency manipulator" in its semi-annual currency report, the House approved a bill in September authorizing duties on imports from countries with "undervalued currencies." (The last time a country was cited for currency manipulation was in 1994. The accused? China.)

A tough stance against China may sit well with a recession-weary American public, eager to get back to work and ready to scapegoat China for "stealing jobs." But China is none too impressed. Its Ministry of Foreign Affairs opposes the bill, deeming it an act of "protectionism" that could fray US-China relations and damage both countries' — if not the world's — economies.

In addition, China is just as eager to score its own domestic points by standing up to foreign "bullying," especially since aggressive currency reform would slash profit margins in China and inflict tremendous stress on the country's export-driven economy.

The Impact of Currency Change

With all the posturing and finger-pointing, it's not certain that overhauling China's currency policy will benefit the American economy in a meaningful way. In reality, it could do more harm than good.

In the first place, China controls its exchange rate by buying massive amounts of US Treasury notes and bonds. Should the Chinese government allow the yuan to float, interest rates would likely rise Stateside, putting a crimp in America's prospects for a robust recovery.

Furthermore, most American businesses have supply chains that are heavily concentrated in China. A stronger yuan means their costs will rise, and, eventually, it's the already overextended American consumer who will pay the price.

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