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Weekly Comment

China: a victim of trade wars?

02-Oct-2006

If the Chinese government gives in to mounting international pressure to revalue its currency, it could spell the end of cheap exports, a move that many anticipate would have a knock-on effect on raw materials costs for the food industry. But China may prove to be a less ready victim of western bullying than some expect.

Since China opened up to Western trade, the food ingredients sector, like other industries, has been growing apace and exerting price pressure on the same products supplied by US and European companies. In the past decade alone, the Chinese food ingredients sector has seen a ten-fold increase in business.

The functional food industry in China, for example, is turning over US$200m per year.

China has long been accused of keeping the yuan artificially low to gain a trade advantage... which has made its trading partners maintain that a solution to the world's woes would be a more flexible Chinese currency and so a less competitive China.

The result: a US led international campaign to make the Chinese revalue their currency upward.

This included proposed US legislation to impose a 27.5 percent tariff on all China's exports to the US unless there was a significant yuan revaluation.

The mounting pressure last year made China budge after a decade of linking the yuan to the US dollar at a fixed rate. It revalued its currency by 2 percent to 8.11 yuan per US dollar, compared to the pegged rate of 8.277, which had been in place since 1997.

But the initial positive global response to what was considered a good first step soon turned to a resurgence of criticism when the newly adopted managed floating exchange rate had little further impact on the yuan.

Last week China again played along with the big economic powers, responding to continued US trade-policy-pushed-as-currency-diplomacy with another minor upward revaluation of the yuan.

Again, this has resulted in the suspension of the threatening US legislation that has been a sword hanging over its trading arrangements.

But as Steve Hanke, professor of applied economics at The John Hopkins University in Baltimore points out, trade sanctions may ultimately be less damaging to China than the effects of a yuan revaluation - deflation and recession. This goes a long way in explaining the safe distance China has been keeping.

Hanke's estimates suggest that a 20 percent yuan revaluation against the dollar would result in a deflation of at least 15 percent. A 40 percent revaluation could lead to a 30 percent deflationary surge.

And according to Nobelist Robert Mundell, honorary president of Beijing's Mundell International University of Entrepreneurship, a substantial yuan revaluation would cut foreign direct investment, cut China's growth rate, delay convertibility, increase bad loans, increase unemployment, cause deflation distress in rural areas, destabilize Southeast Asia, set in motion more revaluation pressures and weaken the external role of the yuan.

It is no wonder that China does not seem to be jumping at this rosy alternative.

China also has regional history as a first hand example of this kind of economic damage. In the 1980's and early 1990's, Japan was the chosen target for its contribution to the growing US trade deficit. The US demanded that Japan either strengthen the yen or face trade sanctions. Japan ceded to pressure, and was faced with a deflationary slump. And the US trade deficit didn't disappear.

Similarly, although China is currently held responsible for about a quarter of the US trade deficit, a yuan revaluation may not be the quick fix that the super power is hoping for. With global production being highly mobile, if Chinese competition were to be diminished, US demand for foreign goods would simply shift to other countries.

China has so far been relatively adept at keeping the US off its back through a series of symbolic concessions. Understandably, this could be a state of affairs that the nation will try to prolong as much as possible. But if China ultimately cedes to international pressure demanding a free-floating yuan, the country needs to have developed the necessary infrastructure and markets for its currency to be able to support the shift.

Otherwise, continued antagonizing from the US and others could have more serious consequences on the world's most populous country than trade wars merit.

Lorraine Heller is editor of FoodNavigator-USA and is a specialist writer on food industry issues. With an international focus, she has lived and worked in the UK, Cyprus and France.

If you would like to comment on this article, please contact Lorraine Heller .

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