An Inside View on China's Currency

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"These numbers show just how little motive China has to end its currency manipulation unless it is pushed to do so," Sen. Chuck Schumer (D-N.Y.) said recently. His statement followed the release of new data showing that the U.S. trade deficit widened to a nearly two-year high in the month of June, thanks largely to more imports from trading partners, and fewer exports in general.

The U.S. trade gap with China in particularly widened 17% from May, to $26.15 billion. That marks the widest level since October 2008. In turn, China's trade surplus swelled to $28.7 billion, an 18-month high, as exports surged ahead of imports.

The trade deficit will likely cause a downward revision in second-quarter gross domestic product, since GDP = consumption + investment + government spending + net exports.

Of course, this only fuels lawmakers' fiery belief that China is artificially inflating its currency to subsidize its export economy, causing global imbalances abroad -- particularly, some believe, in the U.S.

As the U.S. contemplates pulling itself out of this slow-growth hole, some experts are calling for a restructuring of the U.S. economy, particularly a resurrection of our manufacturing sector. Of course, we'll need China's help to shift the way the world economy operates.

After taking a hiatus during the global recession, China had begun to let its currency edge higher in a managed float – albeit at a turtle's pace thus far. But last week, China took a step backwards, pushing the yuan lower against the dollar. However, most took the move to mean that China wanted to show downward movement as well as upward movement, mimicking a normal floating currency. (I think it's no coincidence that the move follows a moderation in China's recent manufacturing data.)

A growing chorus in Congress -- Senator Schumer being one of the most outspoken -- contends that a gradual policy isn't swift enough. But in Hong Kong, T. Rowe Price's Anh Lu, manager of the New Asia Fund (FUND: PRASX  ) , has an entirely different opinion. Lu argues that allowing the yuan to suddenly appreciate could cause large, rapid imbalances within China's economy.

"The reality is China is a large economy -- you're talking about 1.3 billion people," Lu said. "I think stability is a very important part of this whole process. I think any signs of instability are perceived -- and rightly so -- by the policymakers to be very dangerous, because [it's a] balancing act."

China has a very rapidly growing economy. Its second-quarter GDP superseded Japan's, officially making China the second largest economy in the world. But there's a large divergence in that wealth; some people are very affluent, while others still live in poverty. Some of them are only getting poorer.

Lu argues the best way to maintain stability in China is to make sure people have jobs. This gets to the core of China's rationale for its currency policy: "If there's a rapid appreciation of the currency, and there's a rapid loss of market share on the export side -- exports account for 30%-40% of the economy -- you have rapid loss of jobs in those sectors, you're going to create a lot of dislocation in the short term."

And while a rapid loss in jobs could mean that the U.S. or other countries gobble up a piece of China's artificial economic pie, it could also create adverse global imbalances in the short term, as economic forces readjust. A contraction in China's exports could lead to slower growth in China, which could cause slowdowns in other economies or companies dependent on business there. What's more, if China loses exports, perhaps Cambodia or India will fill the void, leaving the U.S. still hung out to dry. Remember, much of our country's manufacturing sector has eroded over the past 50 years, and we'd need time to get it back up to speed.

Perhaps there are other ways beyond China's currency to boost U.S. exports or help us cash in on China's rapid-fire growth. The Obama administration is attending more forums in China, and talking about new trade accords with other countries, according to The Wall Street Journal.

Making lemons out of lemonade
While certain members of Congress blame China for stealing American jobs, Americans can still try to cash in on China's growth by investing in individual stocks. Online businesses in the region, like SINA (Nasdaq: SINA  ) , Internet search engine Baidu (Nasdaq: BIDU  ) , online travel company (Nasdaq: CTRP  ) , or New Oriental Education & Technology (NYSE: EDU  ) , all exhibit strong growth. They should all continue to benefit from the evolution of China's consumer class.

Investors can also cash in through American companies. Any U.S. stock that does a large portion of business in China has the potential for rapid growth. Caterpillar (NYSE: CAT  ) or Ford (NYSE: F  ) , which export heavily to China, could be interesting ways to gain international exposure through American companies.

What do you think? Is China partly blame for U.S. economic woes? Share your opinion in the comment box below.

Fool contributor Jennifer Schonberger does not own shares of any of the companies mentioned in this article. You can follow her on Twitter. Baidu and New Oriental Education & Technology Group are Motley Fool Rule Breakers picks. Ford Motor and SINA are Motley Fool Stock Advisor recommendations. International is a Motley Fool Hidden Gems choice. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.

Read/Post Comments (2) | Recommend This Article (2)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 17, 2010, at 12:24 PM, Jazzenjohn1 wrote:

    We're supposed to accept china's currency manipulation, and the damage it causes our economy, because if it were made fair it might disrupt their economy??? This Anh Lu sounds like a chinese government stooge rather than an impartial observer.

    We should have the same rules they apply to us, nothing can be sold here unless it is made here and a U.S. company gets to own half of the joint venture. If that policy is fair and reasonable for them, it should be fair and reasonable for us as well.

  • Report this Comment On August 17, 2010, at 4:44 PM, arusha22 wrote:

    What China want's to do is sell as much as they can to the US, and buy as very little as possible from the US in the way of goods and services. This is not balanced trade it is lopsided in favour of China. The fault also belongs to American buisness as they have distroyed the American manufacturing base because of their greed. Go to any store in the US and try buying a consumer item that is not made in China. Chinese also have become masters at planned obsolescence as most of their products are designed to malfunction after a short period. This gives them a chance to sell more junk and collect more dollars increasing the trade surplus to billions more. I am all for free and balanced trade but not one sided trade.

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