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Experts Speak About Rise of Chinese Yuan
Any business already in China or contemplating entering that market likely is aware of the ongoing appreciation of the Chinese yuan (CNY). Since June of 2005, the CNY has appreciated a total of 9.6 percent against the declining U.S. dollar. It is forecasted to reach a rate of 7.0258 against the U.S. dollar by April 2009, down from 8.2765 in July 2005, according to Jane Mezera, vice president of foreign exchange trading for U.S. Bank in Milwaukee.
Mezera and Menzie Chinn, professor of economics and public affairs at the University of Wisconsin-Madison, addressed the consequences of this trend for U.S. trade policy and U.S. companies on September 24 at the Fluno Center for Executive Education on the UW-Madison campus.
Much of the concern about the CNY stems from the $240 billion annual U.S. trade deficit with China. According to Chinn, however, it accounts for only one-third of the overall U.S. trade deficit, and some part of its recent growth is due to changes in country-of-origin labeling. Of greater concern to Chinn is the fact that China’s global trade balance has surged at the same time the CNY has appreciated and China’s foreign exchange reserves have grown into the largest in the world. “As China and other East Asian countries continue to accumulate dollar assets, they become ever more vulnerable to dollar declines,” he said, which “might lead to herding behavior on the part of central banks, leading to a sharp fall in the dollar’s value.” The situation also could cause problems for the United States if these countries dumped their dollar reserves at the same time, he said. Further, instead of using its foreign exchange surplus to recapitalize its economy, Chinn said that China hopes to diversify its surplus by purchasing physical assets such as U.S. companies. Initial attempts to do so, such as the 2005 bid for Unocal by China National Offshore Oil Corporation, have led the U.S. Congress to pursue tariffs on Chinese imports. These congressional efforts have stalled as they would have violated WTO rules; however, Chinn expects a similar reaction to any future Chinese bids. In addition to cautioning Congress against taking non-WTO compliant actions, Chinn urged policymakers to broaden their approach to the foreign exchange issue beyond China. Any solution must also address U.S. oil dependency, he said, as Middle Eastern oil-exporting countries are even bigger purchasers of dollar assets than China is and have reserves probably equal to China’s.
The concern for U.S. companies resulting from China’s currency appreciation, of course, is the increasing cost of doing business in that country. As Mezera pointed out, that situation is no different from the U.S. experience with other developing markets. While there is no “magic formula” to head off such cost increases, companies can implement some hedging strategies, she said. Three common strategies are the non-deliverable forward (NDF) contract, which can help protect companies against larger-than-expected currency changes; the non-deliverable option (NDO), which functions like an insurance policy in the event of a huge appreciation; and the non-deliverable collar, useful in the unlikely event that the CNY would depreciate.
Chinn recommended that the United States should continue to press for gradual, albeit more rapid, appreciation of the CNY in order to help slow China’s accumulation of dollar reserves and avoid potentially troublesome congressional action. Chinn and Mezera agreed that China will not allow its currency to dramatically appreciate given political and economic concerns. “China is definitely the engine of growth, but conversely they’re also dependent on the rest of the world for their growth,” said Mezera.
The September 24 event was sponsored by CIBER and the Center for World Affairs and the Global Economy (WAGE) and was co-sponsored by the Madison International Trade Association (MITA), and the Center for East Asian Studies (CEAS).