China’s Supply Chain: The currency factor
We know that China has earned the sobriquet of the “world’s manufacturing workshop”. It earned this title because several developed economies – US in particular - found it cheaper to build/buy from China. What was (is) the reason for China’s cost competitiveness? Labor cost, technology, supply clusters, quality control, infrastructure….and to a significant extent, its pegged currency. It is this last factor that warrants a deeper look.
How is China able to keep its currency under control? Because, it adopted a managed floating rate system in 1994 (thanks to it, the currency trades at an attractive ~6.8 RMB to a USD). But what about the huge trade surplus with US and the flood of FDI’s pouring into the country - surely, that would put pressure on the exchange rate, wouldn’t it? Not, if the “excess” is mopped up by the regime and put into a ‘bin’ labeled foreign currency reserves. Totaling around USD 2 trillion plus, this huge forex reserve is a treasury chest that cannot be kept idle. So, what does China do – it invests in the safest instruments available i.e. US Treasury bills (close to 800 billion USD as of June ‘09). What does the US government do with the money? It needs the money to fund its expenditure on programs/projects (in effect, cover its fiscal deficit). Assuming that the money goes into building the nation and there-by its businesses, who does the US business look to for low-cost, quality inputs – China, naturally.
So, this cycle – vicious for some; pleasant for others – continues and keeps China’s Supply Chain chugging. So, does that mean that once China decides to free up its currency, this cycle would cease? Well, there is enough debate on this among the qualified elite that I would prefer not voicing my opinion. But suffice it to say, China’s exports will certainly not be immune to any currency movement. Would it mean that China’s Supply Chain would stop chugging? Certainly not!! Exports, unlike common notion, contribute to less than 15% of China’s GDP (not in the 30’s or 40’s as was thought previously). The domestic economy has grown and is set to grow much more in the coming years to keep the demand pipeline filled and the supply-chain moving.