A Cheaper Currency Can’t Rescue the Chinese Economy

The latest figures show that China is putting paid to the simplistic story that a cheaper currency on its own boosts exports. Don’t be fooled. The performance of the Chinese economy over the past year is a demonstration of the truth of that.

Since Aug. 11, 2015, when the People’s Bank of China, the central bank, abruptly depreciated the renminbi by 1.9 percent, the currency has fallen significantly against those of its major trading rivals. As of last Friday, Aug. 5, it had fallen by 8.6 percent against the US dollar, 10 percent against the euro and by an amazing 31 percent against the Japanese yen.

Yet, according to figures supplied by the PBOC, since June of last year, exports have fallen by 6.25 percent, belying the myth that exports should have risen. During the first six months of this year, moreover, they fell by 2.1 percent on an annualized basis. July exports contracted by 4.4 percent annually, with demand from major export markets remaining sluggish except for the United States, whose economy continues to lead the west in line with expectations, with gross domestic product accounting for 28 percent of the world economy according to the World Bank. Even though the US economy continues to expand, however, exports to the US fell by another 2.0 percent, up from a dire 10.5 percent collapse in June.

Highly price-sensitive textiles exports were down by 3.7 percent in dollar terms during the first half of this year as other cheaper countries including Bangladesh, Vietnam and others continue to eat into China’s share of the market. Exports of that other price-sensitive sector, home appliances, fell by an annual 1.1 percent during the first four months of this year.

But why have China’s exports fallen?

As we pointed out in our book, Trade Myths: How Multinationals Influence Trade Balances, exports consist of inputs, many of which have to be imported or are priced in US dollars. So take textiles. Their major input is the raw material of cotton, silk, etc.: all of these raw materials are priced in US dollars. Thus, simplistically, China's input cost of raw materials rose by the amount which the renminbi sank - by 8.6 percent over the past year.

In addition, it is likely that the price of raw materials – cotton, silk and the like – must have risen, courtesy of terrible weather impeding harvests. Add to this China’s steadily rising labor costs and the falling productivity of textile workers, it shows that that in reality, the price of China's exports didn’t fall by that simplistic notion of the renminbi having fallen by 8.6 percent against the US dollar.

A similar argument applies to so-called white goods, home appliances. Major input raw materials are plastics and metals – raw materials which ultimately are priced in US dollars. So, at its simplest, prices of metals and plastics have risen by 8.6 percent in renminbi terms over the past year. Despite its leaps in domestic origination of products, China continues for far too much of its economy to depend on assembly of goods from rich countries, turning them around as finished products and sending them back.

It is unclear whether the dollar costs of these raw materials have risen or fallen, but we can imagine that labor costs must have risen, and that unit labor costs must have risen all the more because of falling productivity. According to the National Statistical Bureau, wages in manufacturing in China increased to 55,324 renminbi per year in 2015, an all-time high. The so-called China advantage of low wages has all but disappeared, rising from a record low of just 597 renminbi per year in 1978. But in addition productivity fell because of falling demand.

So don't keep falling for this myth that a falling exchange rate boosts exports. Were it that simple.

Enzio Von Pfeil is a Hong Kong-based independent financial advisor who blogs at Private Capital Ltd.