A Strong Dollar Hurts China More Than the U.S.

A Strong Dollar Hurts China More Than the U.S.

 Rich Miller  Enda Curran

 endacurran

December 9, 2015 — 8:49 AM KST

• Yuan's tether to greenback means both rise on higher rates
  
• This hurts China more as its economy depends more on trade
• 
  

Here’s a surprise for China critics such as Donald Trump who brand the country a currency manipulator: The biggest loser from a rising dollar won’t be the U.S. 

It will be China.

That’s because the Asian nation has tethered its currency for the most part to the greenback to enhance financial stability. As the dollar advances against most currencies across the world on expectations of rising U.S. interest rates, the yuan does, too. China suffers more, though, because its slowing economy is almost twice as dependent on trade.

“It’s a problem,” said Yukon Huang, a senior associate at the Carnegie Endowment for International Peace in Washington and a former World Bank country director for China. “Excessive appreciation at a time when the economy is sinking is a bad thing.”

That’s why he and other economists, including former U.S. Treasury Secretary Lawrence Summers, expect China will try to loosen the yuan’s ties to the dollar and allow a depreciation of the currency. Such a move, though, figures to trigger even more political criticism with the U.S. presidential election less than a year away.

“They’re stuck,” Huang said. “If they depreciate the currency, they’ll come under attack.” Yet “they need to do so.”

Trump: China ‘Manipulation’

Republican presidential front-runner Trump has called China the “No. 1 abuser" of the U.S. and has accused it of “wanton manipulation" of its currency.

The U.S. economy certainly has been hurt by the dollar’s advance since mid-2014. (It is up more than 20 percent against a basket of currencies during that time, though only about 3 percent against the yuan.) The stronger greenback has made American companies less competitive in world markets, helping push exports down 4.3 percentthrough the first 10 months of this year.

But China faces even bigger difficulties from a strengthening currency. Trade amounted to 42 percent of its gross domestic product last year, compared with 23 percent for the U.S.

Sudden Rise

A sudden 10 percent rise in the dollar slows Chinese economic growth by almost one percentage point, nearly double the impact on the U.S., according to computer simulations run by economists at Goldman Sachs Group Inc. in New York.

“China is more open to trade,” Goldman chief economist Jan Hatzius said in an e-mail. “So the same exchange-rate move results in a bigger GDP effect.”

The yuan has advanced almost 15 percent against a basket of currencies since mid-2014, according to a trade-weighted index compiled by Westpac Strategy Group in Sydney. The rise came at a time when China was already losing competitiveness to countries such as Vietnam and Thailand because of its higher labor costs.

During the past 10 years, the yuan’s 26 percent appreciation against the dollar is second only to the Swiss franc’s 31 percent gain among major currencies, according to data compiled by Bloomberg. China’s central bank set the yuan reference rate at 6.4078 per greenback on Dec. 8.

The result of the currency’s recent rise has been slower economic growth. GDP expanded 6.9 percent in the third quarter from a year earlier, its worst performance since early 2009, as the drag from weaker manufacturing and exports offset strength in services and consumption.

A stronger currency also hampers China’s efforts to ward off deflation because it puts downward pressure on import prices. Chinese producer prices fell 5.9 percent in October from a year earlier, the 44th consecutive monthly decline.

Fragile Markets

“China will continue to face deflationary pressure, particularly in its manufacturing sector” if the yuan continues to appreciate along with the dollar, Xiao Geng, a professor at the University of Hong Kong, said in an e-mail. He nevertheless expects China will avoid depreciating its currency on concern that such a move would upset fragile domestic financial markets.

Another reason to hold the yuan steady against the greenback: a build-up in dollar-denominated debt by Chinese companies. A cheaper yuan makes it tougher for them to service those obligations.

If China does elect to retain its currency regime, it must be prepared for a further broad rise of the yuan in line with the dollar.

Climb to Parity

Allen Sinai, chief executive officer of Decision Economics Inc. in New York, sees the U.S. currency climbing to 140 yen or more and strengthening to parity or better against the euro by the end of next year as the Federal Reserve increases interest rates while other major central banks ease policy. The dollar was at 122.93 yen while the euro stood at $1.0892 as of 5 p.m. Dec. 8 in New York.

Stephen Jen, co-founder of SLJ Macro Partners LLP in London and a former International Monetary Fund economist, said China’s current policy mix “is not consistent or sustainable over time.”

That’s because it’s trying to achieve something akin to what economists call the “Impossible Trinity.” It’s reducing interest rates to boost growth while resisting a depreciation of its currency as money flows out of the country.

“They’re likely to have to devalue,” said Summers, now a professor at Harvard University in Cambridge, Massachusetts. “You can’t have relatively open capital markets, monetary stimulus and a stable currency.”

http://www.bloomberg.com/news/articles/2015-12-08/biggest-loser-from-stronger-dollar-may-be-china-and-not-the-u-s-