June 3, 2011

Rising Yuan a Risk to China Stability, Says Benjamin Wey: Weekend Interview

New York Global Group’s China expert cautions that yuan rise against dollar can lead to unrest

As China plays an increasingly large role in world economics, its position in such entities as the International Monetary Fund (IMF) and global markets means its financial and political health are more important than ever to both its trade partners and financial institutions across the world.

China’s currency, the yuan, is at a record high against the dollar, and according to Benjamin Wey (left), president of New York Global Group and China expert, that can have serious consequences for the global economy.

In a recent interview, AdvisorOne spoke with Wey about the rising value of the yuan against the dollar and its ramifications.

How much has the yuan appreciated against the dollar?

Wey: So far this year, Chinese currency has appreciated 1.2% vs. the U.S. dollar. Since [U.S. monetary] policy loosened up last year, the yuan is up 5.4%. It’s a gradual upward trend.

Which factors are responsible for the appreciation of the yuan against the dollar?

Wey: The first is the depreciation of the U.S. dollar across the world. The dollar is less valuable due to the Fed’s loose policy and lower valuation. On the China front, its tremendous growth means that the country is faced with significant pressure from inflation, which this year is particularly severe. China can do one of several things: it can raise the value of its currency, and it can reverse or reduce some of the current trade imbalance with other countries.

How much are we talking about?

Wey: There is $30 billion a month in foreign currency sent to China through trade . . . That $30 billion could add to the liquidity of the Chinese economy by appreciating it further and making imports more expensive. That action will cause importers to buy more by paying in foreign currency, and that causes Chinese foreign product exports to drop due to their greater cost.

Chinahas been steadily raising the required reserve ratio (RRR) of its banks and increasing interest rates. How do you see that affecting the country’s inflation?

Wey: It’s a very effective measure: the central bank of China taking away the excessive liquidity of banks is part of collective efforts to beef up the local economy and to contain inflation. That’s its number one objective.

Its secondary objective is to maintain a balance between unemployment and inflation. It’s a balancing act all the time, because the more inflation, the more pay people get. By not having inflation, there’s too much constraint on the economy. Tightening policy, as they’re doing now, could reduce exports and kill jobs.

And you said that allowing the yuan to appreciate could also cause significant problems in China.

Wey: Any significant appreciation of the Chinese yuan will lead to massive unemployment, which will then threaten social and political stability in China. More than 50% of China's GDP is exported oriented, and export volume is directly tied to the value of the Chinese yuan. The Chinese government adjusts

its currency or makes policy changes under these basic parameters. The biggest influencer currently is the U.S. Fed’s large stimulus boost, and in the end, the U.S. cannot directly change a country's sovereign rights to its own currency.

Is there social unrest in China now?

Wey: There are pockets of social unrest, but not on a national basis. There is no adversary political party that could stand up against the controlling regime. I don’t see it as a problem. But an economic crisis could drive political change, and that’s why the government tries to keep things stable and control inflation, and hope that domestic markets will continue to rise.

China is very interesting; it has a population five times the size of ours [in the United States]. They all want the same lifestyle as the U.S. That’s the driving force behind Chinese economic growth in the last 10 years. The rise in consumer wealth is driving the export economy.

We’ve seen headlines in the past few days that wages in China are rising to the extent that businesses are beginning to look elsewhere for manufacturing to lower costs.

Wey: Currently there are intensive labor pressures and labor cost increases. Factories in southern China are suffering, and many export orders are unable to be filled. There is a chain reaction from U.S. buyers, especially importers from North America. Quite a few factories have shut down, especially marginal businesses that used to be simply making very small profit margins.

From an importer’s perspective, those who buy from China, the traditional understanding of China as cheap labor is probably gone forever. The labor cost is increasing. But no other country can replace China in terms of economic power and production, so shifting products to other Asian countries is not something we’re seeing. Hopefully it will not drive inflation too much.

We’ve also seen that luxury goods imports are booming in China. Could that affect the economy?

Wey: Chinese typically have an insatiable appetite for luxury goods such as Bentley and Prada. I can certainly see that, but also caution that the Chinese government has the ability to levy tariffs. So if some products become significant rivals with Chinese domestic brands, there will be something the Chinese government will do to influence imports. Market forces will take place if Chinese consumers become wealthier and there is a tremendous demand for luxury goods. There will be more in the future. One cannot stop the wealth of the Chinese.

What about luxury companies seeking IPOs in China and opening more shops there?

Wey: Currently that’s not a significant consideration for tariffs, but I can see as more luxury brands open shop in China they will be taxed at pretty heavy rates, like luxury cars. A Rolls-Royce, for example, costs about three times as much as it does in the U.S.; the tariff is 150% of the cost of the vehicle. It depends on where it’s going, how big the market is, will it become a market. There will be an adjustment in the Chinese taxing system.

The government has been encouraging overseas brands to open up shop in China so that goods can be properly taxed, and the revenues stay in China. The Chinese consumer will have to live with that, have to pay more in China. That’s why many Chinese tourists go to Fifth Avenue, because things cost twice as much in Beijing. Chinese consumers are buying a lot and bringing it back.

For more AdvisorOne coverage of China, go to our ‘FPA in China’ dispatches.

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