What's good for Chinese manufacturers, however, is raising howls of protest elsewhere in the world. Currency analysts such as Montreal's BCA Research regard the yuan -- pegged at around 8.3 to the dollar for a decade -- as undervalued by 20%-30%, given China's swelling foreign reserves, which leapt by 35%, to $286 billion, last year. Now, with the yuan even cheaper thanks to the dollar's dive, China's export machine is really roaring -- at the expense of Japan, Mexico, South Korea, and other nations with floating currencies. U.S. manufacturers also claim they're being hurt by an artificially cheap yuan. In May, China's exports surged 37% above last year's levels, despite tepid growth in the U.S., Europe, and Japan. Beijing University economist Song Guoqing expects China's exports will be up 30% for the year, to $424 billion.
This success is sparking renewed calls for Beijing to revalue the yuan, or even let it float. And there are indications that the jawboning may be having an effect. On June 16, U.S. Treasury Secretary John Snow stoked speculation that Beijing may make a move by saying Chinese leaders had indicated "that they intend to create more flexibility" in the currency.
Seoul has intervened in currency markets to limit the won's rise against the yuan, which hurts Korean manufacturers of everything from textiles to cell phones. "The Chinese currency needs to strengthen," says economist Kang Sam Mo of the Korea Institute for International Economic Policy, a government-funded think tank. China ran a $103 billion trade surplus with America in 2002. Washington's National Association of Manufacturers says the politically sensitive gap could hit $330 billion in five years if historical trends continue.
But absent a big political push by Washington, hopes for a Chinese revaluation may be misplaced. The reason: Exports are one of the few brights spots in the Chinese economy. After gangbuster 9.9% growth in this year's first quarter, the economy is slowing. The deadly severe acute respiratory syndrome (SARS) epidemic slowed consumer spending this spring at a time when the economy was already decelerating from a cyclical peak. If it weren't for SARS, says economist Song, Beijing might have revalued the yuan modestly this summer. "But the economy's strength has shrunk," says Song. "For now, the government wants to keep the peg and see what happens next."
What's more, the Chinese economy is in the midst of a painful transition. Private estimates put unemployment as high as 15%. And joblessness is rising, as Beijing continues to restructure agriculture and close state enterprises. Meanwhile, Beijing is trying to put the brakes on new lending after allowing bank loans to soar by 34% in the past two years, an unsustainable pace.
The easy-money strategy has worked wonders in propelling economic growth since the 1997 Asia crisis and through several years of domestic deflation. But it has come at a cost. China's $1.8 trillion in outstanding bank loans are equal to 140% of its gross domestic product, compared with 88% in 1996. And nonperforming loans are high at China's four major banks, all of which are technically insolvent. Since 1998, Beijing has spent $200 billion to recapitalize banks and take over bad loans. Standard & Poor's (MHP
) estimates that a further $500 billion is needed. The lending spree also has fed a real estate bubble that Beijing is trying to gently deflate. In mid-June, China's central bank issued new curbs on property lending.
Given its precarious finances, Beijing is wary of doing anything to hurt exports. Morgan Stanley (MWD
) chief Asia economist Andy Xie warns a currency revaluation might "destabilize" the economy by encouraging greater capital inflows that would further juice the overheated property sector.
Washington is also performing a delicate balancing act. That's because China is now second only to Japan in purchases of U.S. Treasury bonds. Its holdings of American debt have risen from $82 billion a year ago to $119 billion, according to the Treasury. Washington wants to be sure China keeps recycling foreign exchange earnings into U.S. government paper. Treasury Secretary Snow told BusinessWeek he expected China to loosen its currency "as part of an overall package of reforms." Snow said a widening of the yuan's trading band would be favorable but should be "coupled with banking reforms and greater transparency."
Political pressure may force China to revalue at least a bit -- perhaps 2.5% to 5%, analysts say. If U.S. unemployment remains high in the runup to the November, 2004, election, expect more pressure from Snow and other U.S. officials. China's rising trade surplus is sure to draw more attention, given that the U.S. has lost 2 million manufacturing jobs, 10% of the total, in the past two years, according to the NAM. "We must press China to end the manipulation of its currency and allow the yuan-dollar exchange rate to be determined by the market," NAM Vice-President Franklin J. Vargo said at a congressional hearing in May.
It would take more than a modest revaluation to slow China's export juggernaut, though. So while a quick revaluation might look politically astute, it would not avert a trade showdown. By Mark L. Clifford in Hong Kong with Dexter Roberts in Beijing