Will the yuan rise? Will the sun?

PUBLISHED : Tuesday, 02 November, 2010, 12:00am
UPDATED : Tuesday, 02 November, 2010, 12:00am

Lucy Liang, a sales manager for Jiangsu Zhongxin Toys, disappointed potential clients from the United States and Europe inspecting the pink and yellow teddy bears crowding the toymaker's stall at the mainland's biggest trade fair in Guangzhou. 'My boss ordered us to turn down all the orders for the good of the company, because the yuan may rise, crimping profit margins,' said Liang. 'Even first-class economists can't predict whether the yuan will appreciate or by how much. How can we?'

Bloomberg in Guangzhou, SCMP, November 1

Iam not a first-class economist, nor any official class of economist at all. I took my degree in classical history. Yet I can easily predict for Ms Liang whether the yuan will continue to appreciate against the US dollar and by how much.

Will it continue to appreciate? You bet.

By how much? Fasten your seatbelt.

The reason I can be so confident lies in the evidence of the chart. Over the last 10 years, China's balance of payments surplus has averaged an annual 8 per cent of gross domestic product, which is an astonishing statistic. This in turn has driven China's foreign reserves to US$2.65 trillion, which rivals Everest as a mountain.

Perhaps a first-class economist can name a major economy that has previously run a balance of payments surplus at 8 per cent of GDP for 10 years, but I think it's one for Guinness World Records. Those reserves certainly go in the book as a record. They may stay in there forever.

What cannot last forever is the imbalance that created these reserves. China's entire financial system has come heavily under the strain of supporting it. Nature's remedy, a strengthening currency, is forcing itself on Beijing at last. The yuan is going up.

And it will continue to go up until many more bosses than Ms Liang's alone give up the game and cut back their exports while many Ms Liangs develop a taste for foreign goods, stimulating imports.

In fact, judging by experience elsewhere, the strengthening of the yuan is likely to continue until the imbalance swings far the other way, and if the ultimate bosses in Beijing try to resist the movement of this pendulum, they may find themselves knocked sideways by it.

I can say all this with confidence because these are nature's workings, just as gravity or fluid dynamics are. A physicist may be better at telling you how gravity and fluid dynamics work, but you don't need a physicist to know that they do indeed work.

Likewise, you don't need a first-class economist to be confident that human schemes to interfere with nature's way in the balance of payments may briefly appear to succeed but in the end are always doomed.

So what shall we make of the future of the big toy industry across the border?

It does not look good. Get yourself a new industry in which to be a sales manager, Ms Liang. This one has had 30 years to move upmarket, but many of the companies active in it have not taken that opportunity. They have instead been lulled by plentiful cheap labour and a rigged currency to stay in the same line of plastic rubbish on which they were founded.

I don't say all of them are like that. My favourite counterexample is Johnson Electric, which advanced from friction toy motors to the leading edge in electric micromotors.

But Johnson was always a home for electrical engineers with ideas, quite unlike run-of-the-mill toy producers who found US chains like Wal-Mart an easy sell and only discovered too late that they had really sold themselves, not just their products, to Wal-Mart.

Their future may lie in Indonesia or Sri Lanka, where people are still willing to work for much lower wages than labourers in China earn and where the balance of payments has not been so heavily skewed. This contrast will only grow more stark as the yuan strengthens.

There is no way round it. The pinch on the profit margins of labour-intensive industries that have not climbed out of the low-tech ditch can only grow worse in China. Tell your bosses to stop hoping that the yuan will weaken again, Ms Liang. It won't happen. If that's where they see their future, they're gone.

And don't bother asking first-class economists if this is true. They know that it is, but very few of them can break out of their own mould of qualifying every statement they make.