The Hindu Business Line : 2006 could see significant yuan revaluation

The US and Europe think the yuan is grossly undervalued. They have a point. China has become an export machine. It produces everything from garments and toys to TVs and semiconductors, destined for the West. The plus side is that as the cost structure is much lower in China, the affluent US and Europe consumer enjoys lower prices. Inflation is muted and as China recycles most of its export earnings into American and European bonds, long-term interest rates in the First World are at historic lows. In fact, despite a strong economy, the US yield curve is inverted, with yields on 10-year bonds below those on two years. The latter are higher because of expectations that the Federal Reserve will keep raising short-term interest rates.

The political economy of China's exports is an altogether different matter. Lots of jobs in the US's and Europe's mother and traditional industries have disappeared as companies mothball factories and shift their production to China. While First World consumption is intact and growing, there is no corresponding income generation. The result: less manufacturing employment and a continually rising trade deficit between the West and China. No wonder, China trade and the yuan have become emotive issues for both politicians and the man on the street in the US and Europe.

It is no use saying (like economists) that what is lost in the swings will be gained in the roundabouts. The argument is that the money consumers save because of lower-priced Chinese goods would be spent on other things which only America can make. The jobs lost in dying industries would be made up in new sectors, requiring unique technology and knowledge. The US's future lies in transforming to a `thinking' economy. It must specialise in developing `soft' skills.

Of course, this makes little sense to the unfortunate victims of factory closures. More often than not, they are too old or lack the aptitude and orientation for learning new professions and becoming employable in the so-called `sunrise' sectors of the economy.

It is no coincidence that there is an increasing foreign presence even in the emerging and fast-growing areas of business activity in the US. The rising outsourcing of business services to countries like India is another damaging blow.

China's forex reserves are in the neighbourhood of $800 billion and still counting. It will very soon overtake Japan. It's trade surplus with the US exceeds $100 billion and could top $ 200 billion in the not too distant future.

Because of persuasion from the G-8 countries, China was forced to marginally revalue the yuan last year. But its export surpluses and reserve accumulation will keep exerting enormous upward pressure on the currency.

There seems little doubt that China cannot escape without a significant appreciation of the yuan in the course of 2006.

This has major implications for other Asian currencies including the yen and Indian rupee, which too will move up in the wake of the yuan's revaluation. The US dollar is a good sell against Asia.

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