TRADE: by Jeffry Babb News Weekly
US-China exchange rate battle to affect Australian exporters
, December 13, 2003
Exchange rates - a dry topic? But vitally important to the way we live our lives. Exchange rates affect us all as individuals, and influence the destiny of nations.The basic cause of the turmoil in foreign exchange markets is the United States economy.
Once the US was a relatively autarkic economy - in other words, most of what it consumed it produced itself. The US was the world's greatest manufacturing power.
The Big Three carmakers - General Motors, Ford and Chrysler - ruled the US and by extension the world. Recently, Toyota became the world's second biggest car maker after GM, and Chrysler is owned by the Germans.Mechanism
But now the US imports some US$400 billion a year more than it exports. What usually happens in this situation is that the self-correcting mechanism kicks in - the US dollar falls in value, making imports more expensive and exports cheaper. Thus, the Euro and the Australian dollar have appreciated considerably against the US dollar.
The Australian dollar has appreciated to around 72 cents US and looks like going higher. Already this year, it has appreciated some 25 percent against the US dollar. The reason this has happened is that the Australian dollar is freely traded in world currency markets and reacts to market forces.
But for other countries, the mechanism is not working, because the exchange rate is officially or unofficially managed by the trade partners of the US and maintained at a fixed value other the US dollar.
Japan is experiencing a fragile economic recovery, led by the exporters, and the Yen is unofficially restrained by the Bank of Japan, Japan's central bank.
The Chinese Yuan is pegged to a narrow band against the US dollar and as the value of the US dollar has fallen, so has the Yuan. This means the self-correcting mechanism is not working. Now the US trade deficit with China amounts to some US$104 billion - a quarter of the US trade deficit.
The Bush Administration is in a bind - while the US dollar has fallen, the US Government still officially adheres to a "strong dollar" policy, hence its recent decision to impose quotas on Chinese textile and clothing exports to the US.
The outside world finances the US trade deficit by sending money to the US. If these capital flows dry up and foreigners no longer invest in US assets, then the US will be in diabolical trouble.
With the US is in the midst of an economic recovery - albeit one that is not producing the usual number of new jobs so far - the Bush Administration is under pressure to "do something."
As the Chinese Yuan is traded at a value set by the Government of China, the US is pressuring Beijing to allow the Yuan to appreciate as it would certainly do if it was allowed to find its own level in the market. While China has said it will allow the Yuan to float "eventually", it is a case of "how long is a piece of string?" It could come next week or next century.
With the US manufacturing industry hurting, particularly in the industrial mid-West states in the US that Bush must win to gain re-election, the US Government is in a bind.US tariffs
It is offically a free trader, but as the recent example of the steel industry shows, where the US imposed tariffs on foreign steel, ruled illegal by the World Trade Organisation (WTO), the US will act regardless of its free trade credentials when it feels its vital interests are threatened.
The alternative to the Chinese making their goods more expensive by allowing their currency to appreciate is for the US to impose tariffs, as some influential US lawmakers have advocated.
Such a broad based measure would throw the world trade regime into chaos. The Chinese would probably also impose duties on US goods.
The situation is further complicated by the fact that China, which looks destined to become the workshop of the world, is relying largely on foreign capital and expertise - much of it from the US. Other Asian nations would also be affected.
ASEAN - the Association of South East Asian Nations - is committing itself to a free trade area, to combat the economic clout of China. Taiwan would also be affected. Taiwan businessmen have invested some US$100 billion on the mainland and the economies of the two countries are becoming more closely intertwined.
Taiwan supplies raw materials and capital goods - machinery used in manufacturing - to the mainland and the PRC recently replaced the US as Taiwan's largest trading partner.
Australia would be directly affected if China suddenly fell in a hole, because the China market is powering the boom in Australian commodities exports, such as iron ore and nickel.
So it is not just an esoteric argument - our continued prosperity depends on the China market continuing to absorb our exports.
With China looking more and more likely to fulfil its role as the world's greatest market - a promise held out for it for centuries - we cannot afford to sit on the sidelines.
Australia was in a similar situation with Japan in the early 1990s. The US worked itself up into frenzy about Japanese exports to the US.
As for the US, it has no models and examples - it is the world's leading economic laboratory as well as being the world's leading economy.
It has no others to follow.