A Weak Dollar Benefits Chinese Exports

For those readers who tire of charts: enjoy!

As the "news" continues to trumpet the decline/collapse of the U.S. dollar, many observers seem to have forgotten that the U.S. dollar is the de facto "shared currency" of the world's largest economy and its biggest rising-star economy. Yes, the U.S. and the PRC--China. China's currency (officially the renminbi, a.k.a. yuan) is transparently pegged to the U.S. dollar at about 6.8 yuan to the dollar, down from 8+ a few years ago.

Given that Japan is the world's second-largest economy by most measures, and that the yen is informally pegged to the U.S. dollar (trading in a band of 90-110 yen for years on end), then it could be argued that the world's three largest economies all "share" the U.S. dollar.

Before we explore the consequences of this, let's look at a standard-issue "the dollar is weakening" piece: Dollar's Slide Poised to Continue U.S. Quietly Tolerates Drop, While Trade Partners Fret; a Long List of Negatives for the Currency.

Here's one which actually mentions the trade benefits to China of a weak dollar: Dollar weakness sends ripples across Asia: Scramble to preserve capital and the Hong Kong carry-trade redux.

And just to remind everyone that China's leaders don't sit around tolerating circumstances which are negative for their economy: China Targets Commodity Prices by Stepping Into Futures Markets.

And last, let's establish the primary context of China's leadership: 1 billion poor citizens seeking a better job/wage/life. Here is a puff piece by former U.K. prime Minister Tony Blair which makes one key point: most of China's citizens are still very poor, and thus the leadership is obsessed with "growth" and jobs above all else: China's New Cultural Revolution: The world's largest country has a long way to go, but there's no question it's changing for the better. (WSJ.com)

Superficial stories about China are accompanied by glitzy photos of Shanghai skyscrapers and other scenes from the wealthy urban coastal cities, but the fact is that the consumer buying power of China is roughly equivalent to that of England (51 million residents).

Thus those who believe the vast Chinese manufacturing-export sector can suddenly direct its staggering output to domestic consumers in China are simply mistaken: Chinese consumption is perhaps a mere 1/10th of that needed to absorb the mighty flood of goods being produced by China.

Put yourself in the shoes of China's leadership: what do you care about more: $2 trillion in U.S. bonds or creating jobs for 100 million people? It's the jobs that matter, and despite its very public complaints about the slipping dollar, perhaps China doth protest too much--or more accurately, for domestic public consumption.

The consequences of a weakening dollar are neutral for Chinese exports to the U.S. but positive for exports to Japan and the European Union. Chinese exports to the EU and Japan have risen sharply in the past nine years, and a weak dollar keeps Chinese goods cheaper than rival exports in these key global markets.

Since we have many friends in Japan and my brother has lived in France for 15 years, I can report anecdotally that where Chinese goods were not all that common 10 years ago in Japan and the EU, they are now as ubiquitous there as they are in the U.S.

In other words, the Chinese interest in expanding exports to Japan and the EU is more pressing than the paper loss of a few hundred billion dollars in their dollar holdings.

While Japan is importing huge quantities of Chinese goods (inexpensive due to the weak dollar), its leadership is undoubtedly working hard to maintain its own exports to China (its fastest growing export market) and the U.S.

The only way to do so is to maintain the informal peg of about 90 yen to the dollar. Below 85 yen to the dollar, few Japanese exporters can ship to the U.S. and maintain a profit. With Japanese exports cratering, the Japanese central bank is unlikely to sit idly by as exports to the U.S. implode even further.

From the point of view of Asian exporters pegged to the dollar, maintaining exports and jobs is more pressing than the value of their dollar holdings. Japan would be delighted with a 10%-20% appreciation in the dollar, as would EU exporters being decimated by the weak dollar, and China would tolerate a modest rise in the dollar as long as the rise didn't outprice its goods in Japan and the EU.

Those calling for a full-blown collapse in the U.S. dollar might profitably ask if the dollar's partners--China and Japan--would approve. To reckon them powerless to halt a dollar implosion would be a major mistake because the stakes are beyond high.

Yes, they could unpeg from the dollar, but in this 3-D chess game, radical actions can trigger radical (and unpredictable) consequences, and the basically conservative leaderships in Asia have too much at stake to gamble on abandoning the dollar and the U.S. market.

For the reasons stated here and the chart posted last week, I continue to foresee a significant dollar rally within the next month or two to a "Goldilocks" band--not too high but not too low, either.

Comments

[Golden Oxen:]

Charles, Instead of thinking about who the dollar benefits and doesn't benefit by going up or down, may I suggest that you concentrate your thinking on the dollar itself, what it is, what is it's track record of preserving its value, how many are being produced, how fiscally responsible is the issuer, what are the claims against it, what is the financial situation and savings record of the nation's people that borrow in it, what is the balance of trade situation behind the country, to name just a few. I think you will soon realize that China's export picture has very little to do with the dollar's value.

Oct 12 09:40 PM

[derryl:]

You make a good point about how China's currency peg to the dollar insulates their exports from a falling dollar. That hadn't occurred to me before and I haven't read it before. So thanks for the info.

I'm not sure I agree that the dollar will rally in the near term. Where will the demand for dollars come from to raise its price?

Last spring the dollar's reversal from falling to rising was attributed to a 'flight to safety', but I think it was more a case of foreigners needing dollars to payout their losses on dollar-denominated loans and other dollar debts, a kind of short squeeze cover on dollar debts. If the most pressing of these loan losses have been covered then that market for dollars may have dried up, which would explain the dollar's return to its long term decline.

Foreign central banks have recently begun diversifying their reserve holdings out of the dollar. Central banks of US trading partners like Canada would like to see a strong US$ but lack the means to buy enough dollars to devalue their own currency. Japan is suffering with a strong yen but has not done anything about the falling dollar either. Obama and Bernanke puff the words "strong dollar" out of their mouths but their actions weaken the dollar, and I believe actions tell a clearer truth than words.

The world is awash in trillions of dollars. I just don't see where the buying pressure for even more dollars will come from to rally the dollar from its declining trajectory.

Oct 13 01:07 AM

[John Lounsbury:]

Charles - - -

Between your article and derryl's comment, I think the topic is well covered from both sides. I think Golden Oxen is looking further down the road and those arguments may have merit over three to five years. In the next year, the points that you and derryl have debated are more important factors. Very well presented article.

Oct 14 04:23 PM

[Michael Clark:]

Where will demand for the dollar come from? How about Japan, Taiwan, Korea, Thailand...all the Asian countries who are losing competitive equality with China because of the declining Dollar? They started buying last week. This is a form of allowable protectionism apparently. It is protectionism nonetheless.

Oct 18 08:40 AM

[CautiousInv...:]

Actions by Thailand, Malaysia, Hong Kong Taiwan and Singapore are being taken to slow the pace of the dollar's decline with the secondary objective of repricing their currency values versus China’s, since China has pegged the renminbi against the dollar. Meanwhile, China is gaining market share in international trade and expanding its share of international reserves, making the US every more dependent upon China as a creditor.

Oct 18 09:25 AM