Yuan-China

San Jose Mercury News, July 22, 2005 Friday

A small step to a big change;
China Currency Revaluation a Mixed Bag For the Valley

By KARL SCHOENBERGER, Mercury News

In a move that could bring both gain and pain to Silicon Valley, the Chinese government on Thursday took a modest step to raise the value of its currency.

Beijing, responding to complaints it manipulates its currency to maintain an unfair trade advantage, announced it would no longer peg the yuan to the U.S. dollar at a rate of 8.28 per dollar. Instead, China said it would peg the yuan to a more flexible basket of yet unnamed currencies and raise its value by 2 percent.

The announcement was enough to take some political heat off the yuan debate in Congress, where a bill is pending that would impose punitive sanctions against China if it didn’t float the yuan, which some economists say is undervalued by 40 percent. China’s move was welcomed as a first step toward resolving a contentious and complicated dispute.

”For Silicon Valley it’s generally a good thing, because we’re the sell side in the balance,” said Larry Singer, spokesman for Sun Microsystems, which exports computer network servers to China. “China has been a very successful market for us. My first take on this is that it’s opening up China.”

A stronger yuan makes Sun’s servers cheaper for China to import and more competitive in the fast-growing domestic market. But the yuan appreciation poses a more complex problem for Silicon Valley companies that rely on Chinese electronics factories to produce their goods. The cost of labor will rise with a stronger yuan, making some American-branded products less competitive on global markets.

”I look at it from the point of view of Silicon Valley and its interests in offshoring production,” said Greg Sheppard, executive vice president of the Santa Clara research firm iSuppli. “Once the dust settles and we see the longer trend, this is going to get people to re-evaluate their plans in China. But the yuan is probably going to have to appreciate 10 percent to 20 percent for people to think about moving out of China.”

Wide impact

China’s announcement caused flutters in global currency markets. Because of its massive trade surplus with the United States, China has accumulated large dollar reserves, which it invests heavily in U.S. Treasury bonds that finance the U.S. national debt. But there was speculation Thursday that a stronger yuan may prompt China to shift some its hard cash to other global investment opportunities.

Even though the yuan is not traded on global currency markets, its announcement put downward pressure on the dollar. The greenback dropped in Tokyo, from 113 Japanese yen per dollar to 111. The euro also jumped in value against the dollar.

A major shift in China’s investments could push up U.S. interest rates. Rates for 30-year mortgages tend to follow the yields on 10-year U.S. Treasury bonds. Yields on those securities have been kept low in recent years in large part because the Chinese government has eagerly invested in them. If a stronger domestic currency diminishes China’s appetite for U.S. Treasuries, bond prices may fall and yields rise, likely taking mortgage rates up with them.

In the wake of China’s announcement, the yield on 10-year U.S.Treasury notes jumped to 4.27 percent, up about a tenth of a point from Wednesday. But Scott Anderson, senior economist for Wells Fargo, called that a “knee-jerk reaction” and said China’s move should not have much short-term impact for mortgage borrowers.

”From the home buyer’s view, it’s just another factor that’s going to work against low mortgage rates,” Anderson said of the currency change. “Not only is the Fed raising rates at the short end, but now there’s less foreign buying of treasuries that will keep the long rate low.”

On the positive side, Anderson said a stronger yuan could ultimately help lower the cost of construction materials in the United States. Fewer dollars flowing into China through export purchases will mean a slower Chinese economy, including the construction business, which he said has been “overheating.” With less Chinese demand, U.S. builders could see lower prices for construction materials, he said.

Jerry Chen, director of technology in Mountain View for the Taiwanese company Genesys Logic, said he did not think a 2 percent rise in the yuan will have much effect. “But if the yuan goes up by 20 percent, that could have some serious impact on our business and maybe cause inflation in the U.S. economy,” added Chen, whose company has chips made for it by a Shanghai contractor.

Price hikes

A big appreciation of the yuan would cause steep price hikes at places like Wal-Mart, which is heavily dependent on goods produced in China. That could cause Wal-Mart and other retailers to procure goods from other low-cost labor markets. But it would be more difficult for high-technology companies to move production out of China because they are dependent on China’s supply of skilled engineers, not just low labor costs, analysts say.

”At the end of the day, tech companies may have to eat the floating yuan,” said Dan Hutcheson, chief executive of Santa Clara’s VLSI Research. “By linking the yuan to a basket of currencies, China becomes more global, and it should make things more stable. But does it stop the outflow of jobs to China? Probably not.”

The hollowing of the high-technology industry by moving production and jobs offshore follows the path of low technology industries, and a higher-valued yuan is not going to stop it, Hutcheson said.

”It’s all about the infrastructure of the technology industry and the availability of skilled engineers, and it’s the educational system,” he said. “But I also believe that it’s in China’s own interest to float the yuan, because it brings a huge, isolated domestic economy into the global system.”

The 2 percent appreciation fell far short of the 10-to-15 percent revaluation demanded by Bush administration and Congressional critics, who called for a higher yuan to help alleviate the $162 billion trade deficit with China.

Treasury Secretary John Snow, who has been leading the charge for the administration, welcomed China’s move.

”We will monitor China’s managed float as their exchange rate moves to alignment with underlying market conditions,” he said in a statement. “China’s full implementation of its new currency regime will be a significant contribution toward global financial stability.”

Sen. Chuck Schumer, D-N.Y., one of the sponsors of legislation that would punish China with 27.5 percent tariffs if it doesn’t float its currency, offered tempered praise.

”This is a good first step, albeit a baby step. It is smaller than we had hoped, but to paraphrase the Chinese philosophers, a trip of a thousand miles can well begin with the first baby step,” Schumer said in a statement. “The most significant thing about this move is that the Chinese in effect have conceded that pegging their currency is bad for China, for the world economy, and for the U.S., and we are glad they have come to that understanding.”

Mercury News Staff Writer Sue McAllister contributed to this report. Contact Karl Schoenberger at kschoenberger@ mercurynews.com or (415) 477-2500.