The Impact of Yuan Appreciation

Posted on July 14, 2010 by David Laidlaw 

The People’s Bank of China issued a statement on June 19th that it would allow its currency (the Yuan) to appreciate against the dollar and other currencies.  This statement of principle, without any specifics regarding the mechanism, caused a brief rally in the markets which fizzled out shortly thereafter.

China has pegged its currency to the US Dollar at an artificially low rate.  This exchange rate provides a boost to China’s exports to the US and Europe since consumers here and abroad are able to buy more goods with fewer Dollars and Euros.  China needs a strong export economy to support the massive migration from its countryside to its cities.  Without manufacturing jobs to employ these migrants, there would be massive social unrest. 

The US government has been lecturing China for years to allow its currency more leeway to appreciate.  Our trade negotiators hope that a stronger Yuan will benefit our exports and thus increase our manufacturing as Chinese exporters become less price competitive.  At the margins, a stronger Yuan will benefit companies such as NikeMicrosoft and 3M that have established businesses in China since their goods will be relatively less expensive than under today’s rates. 

However, we do not believe a stronger Yuan will have a tremendous impact on our trade with China.  China’s manufacturing and exports are so strong because of the low wages that Chinese workers garner.  According to a US Bureau of Labor Statistics report from 2007, the average manufacturing worker in China earned $0.81 per hour or 2.7% of the $30 per hour earned by the average domestic manufacturing employee.  Chinese wages are rising as evidenced by labor strikes at Japanese auto plants which produced significant wage concessions.  Regardless of these increases, China’s labor price advantage will persist and not change the balance of trade from its current equilibrium.