Damned if you do; damned if you don't

The financial markets have gone gaga over the Chinese central bank’s announcement over the weekend that they would allow the Yuan to rise gradually. There has been almost unanimous international pressure on Beijing to let this happen for sometime. But then Beijing does not like others telling it what to do (after all, who does ?). It will do what it wants, when it wants. But Chinese reluctance has little to do with foot dragging in international diplomacy. It is caught in an almighty quandary.

If the Chinese central bank does not intervene as it does daily, the Yuan would have surely risen a fair bit by now. And probably suddenly. That would be disastrous for China. China is an export led economy. It’s export operating model is huge scale, low costs and wafer thin margins. Costs are under pressure as wage costs rise and general inflation bites. It can only be partly offset by moving factories to the interior where costs are lower than the coastal provinces. Firstly factories are not so easy to shift. Secondly it is a fair disruption to start all over again somewhere else. Thirdly, costs are rising in the interiors too and might only buy 3-4 years time. This blogger has been stating repeatedly in this blog – China is no longer the lowest wage country for manufacturing – pound for pound, India is cheaper, let alone even cheaper countries such as Vietnam.

Therefore if the Yuan were to rise, and rise fast, the export led economy would massively lose its competitiveness. And the specter of unemployment looms. China’s political and social model is centred around providing jobs and big scale economic improvement to its population. Every year, China adds to its workforce numbers that are equivalent to the population of most countries. Any threat of unemployment is even more disastrous to China than anywhere else in the world.

Every company I know , is already factoring in a much stronger Yuan to its future plans. And that means looking elsewhere for manufacturing. Not shifting factories, as yet, but looking to expand elsewhere outside China. Growth of manufacturing in China is now already a huge challenge – people have started to factor currency appreciation and China is not looking as rosy.

But the option of not letting the Yuan rise is worse for China. That’s what is happening today. The Central Bank intervenes buy buying dollars and selling the yuan. This has caused a mountain of yuan sloshing around China. One obvious danger is inflation. The second serious threat, which has already happened, is massive asset bubbles. Both the stock market and property market have gone crazy. The Chinese suffer from the same universal delusion that property prices will go only one way. We all know what happens when property prices fall; as they surely will.

All this is a massive opportunity for India – the only other country in the world with the scale to take on China in manufacturing. And, India is doing its very best to ensure that it can never compete. Low costs alone cannot win. You need infrastructure, sensible land policy, power, government will. Faced with an open goal, an injured goalie and preoccupied defenders, the Indians are busy trying to dribble in the opposite direction and score an own goal.

Back to China. You have to have some soft corner for a country facing a problem because it has succeeded wildly. It is faced with a piquant situation. Damned if you do. Damned if you don’t.