Part 2: My Conversation with Myself - Dollar Dilemma and the China Complaint!

Alright, alright, too much of Chinese currency talk at the International Monetary Fund (IMF) meetings today. Mirror Image just asked me a question which we missed to discuss the other day. So here it goes -

Mirror Image: The other day, I raised the possibility about the advantage of Chinese people being a greater consumer of American products if China appreciates it currency, which you did not accept, but how about this case - Let's say that a product 'X' is manufactured by American and Chinese manufacturers. Now forget the Chinese consumer, instead, think about American and global consumers. Will it not be advantageous to American manufacturers, if Chinese yuan, also called renminbi, appreciates? Then the American manufactured product 'X' will become cheaper vis-a-vis Chinese manufactured product 'X' (relative to the current levels). Now a higher quality but a relatively cheaper American manufactured product 'X' will be able to compete "fairly" with the Chinese product 'X' in the global market. What's your answer to this?

Me: Very good question. And yes, we should have discussed it the other day. Ok, so here's my explanation - American manufacturers say that the Chinese renminbi is undervalued by about 40%. So, let's assume here that China bows to international pressure and appreciates its currency. Now in reality, even if China appreciates its currency by 40% (which will then become somewhere around $1 = 4.01 renminbi from around 6.69 renminbi now), it would still be cheap to manufacture products in China than in US. Simple reason - US labor costs are too high compared to China's. Apart from this, one point many fail to realize is the supply-chain establishment in that part of the world. China did not become a global manufacturing base in the past 2 to 3 years. It has taken years and years of government planning and investment that resulted in development and establishment of massive supply chains in that part of the world, which subsequently made China a low-cost manufacturing base. Western corporations who manufacture their products in China will simply face an erosion in profit-margins due to the drastic appreciation of the renminbi.

But as I said, the supply chain that exists in that part of the world, from Australia (raw materials) to Japan (R&D, Design and high-end manufacturing) to China (low-cost manufacturing) and not-to-mention the other East/South Asian economies that form a part of this chain, will simply tempt corporations to shift their manufacturing base to nearby low-wage country (possibly India or Indonesia) without affecting the other establishments in the supply chain. And not-to-mention the fact that China will not completely bow to international pressure (so 40% appreciation is a distant dream) and the potential retaliation a communist government may try to do to US companies operating in China.

I understand what many tend to think when they ask for an appreciation in the Chinese currency - their reasoning is that an inflation in the US due to renminbi appreciation is actually good to the US economy, since that would make companies in US, who are hoarding cash now (and the people, to certain extent) to invest, that would spur job-creation and consumer spending in US. But my thoughts are this - just because China appreciates its currency, corporations are not going to shift their entire supply chain and manufacturing base, but instead they would just replace one component in the chain - the new replacement being another low-wage Asian economy.