What Does a Devalued Chinese Yuan Mean for Global Manufacturing?

"Currency Wars" miss the point.

The recent fall in the value of China’s Yuan against the U.S. dollar has generated a big buzz over the last few days. Will the Yuan’s dip help China’s manufacturing base? Will it hurt the West? There’s a lot of speculation and a lot less clarity on the issue. 

Here’s my take:

  1. Most industrial nations produce more domestic goods than they consume. This is fine when they trade their surplus with that of other nations, but it also means that no country is self-sufficient. Trade is essential to enjoy a modern standard of living, so exchange rates matter.
  2. A weak currency gives a manufacturing nation the advantage of competitive export pricing while providing a barrier to imports. This is especially true if most of the manufacturing input costs are denominated in local currency.
  3. Despite the relatively free trade in foreign exchange through a sophisticated global forex market, nations alter their exchange rates through central bank interest rates and capital controls, and by printing money. This is part of the age-old Keynesian/sound money debate economists have fought over for the last 80 years.
  4. Devaluing only works if you’re the only country doing it. Since it’s a transparently easy way to boost exports, everyone wants to do it and this creates conditions similar to the Great Depression in the 1930s.

What’s Happening Now

For China, industrial output numbers have fallen to a declared eight percent or so. However, Chinese output statistics need to be taken with a large grain of salt. It’s very possible that reporting errors and outright manipulation of the figures are at play here.

It’s hard to verify sources of data in China, but what we do know is pretty alarming.

The emergence of a high consumption Chinese middle class is lagging far behind the collapse of the middle classes in Western nations. This is leaving a consumption gap that dovetails with a major hangover from 20th century manufacturing technology: economies of scale.

It’s still a lot cheaper per unit to make 100,000 cars, for example, than 1,000, and this means an inevitable lag when matching output to demand. Put simply, inventories build quickly when we enter a recession, and they’re hard to clear.

Consumer demand isn’t the issue, despite what the media reports. It’s a delayed consumption due to not enough disposable income in consumer’s hands to buy the industrial output.

If the Chinese middle class isn’t there yet and the West is in recession, all the gains in equities worldwide, all the cuts to interest rates and all the money printing in the world won’t help manufacturing until there’s more money in average peoples’ pockets.

In my opinion, how this is achieved is irrelevant. Higher wages, tax cuts, government handouts, devaluation, price deflation — as long as consumers can consume, manufacturers can survive.

Yesterday, the Yuan dropped by almost two percent, which is Beijing’s declared maximum allowable daily drop in their set point regulatory system.

The Beijing government declared a willingness to let markets play a bigger role in setting currency valuations. However, keep in mind that they are the type of government that props up share prices in their major stock market, throwing market pessimists in jail. No one knows what a market solution really means in Beijing.

China’s devaluation solution is a band aid for the real constraint on global manufacturing: flat to falling disposable incomes for most of the planet’s population. Fix that and everything else slides into place nicely.

Written by

James Anderton

Jim Anderton is the Director of Content for ENGINEERING.com. Mr. Anderton was formerly editor of Canadian Metalworking Magazine and has contributed to a wide range of print and on-line publications, including Design Engineering, Canadian Plastics, Service Station and Garage Management, Autovision, and the National Post. He also brings prior industry experience in quality and part design for a Tier One automotive supplier.