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Revaluation wouldn't help everyone

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

Edward Yardeni, Oak Associates chief economist

Sometimes you must be careful what you wish for. That may end up being the case with the US' 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 US 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 US 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 that source merchandise and materials from China.

The yuan has been pegged at 8.28 to the US dollar for a decade,. Critics charge that fixed rate undervalues the yuan by as much as 40 percent, giving China an unfair trade advantage. They point to China's contribution to the record high US$617 billion US trade deficit last year, which included a US$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 Beijing 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 US exports by making Chinese goods cheaper in the US and US products more expensive in China and contributing to job losses at US 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 US 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 US 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 his company was looking to "locate alternative sources" if cost increases appear.

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 US Treasury securities, which has helped keep US 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 US than agree to a big revaluation.

And since US and other foreign companies generate four-fifths of China's exports to the US, they would end up bearing the brunt of any tariff imposed. Xie estimates that could costs US businesses US$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 US government would act to allow something like this."
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