By CRAIG KARMIN and HENNY SENDER Staff Reporters of THE WALL STREET JOURNAL June 29, 2005; Page C1
Chinese takeover offers last week for oil company Unocal Corp. and for Maytag Corp., the consumer-appliance maker, reflect the deepening ties between the Chinese and U.S. economies. But these deeper ties also are boosting the odds of a financial disturbance as trade tensions between the two economic powers rise.
With some members of Congress now threatening tariffs on Chinese goods unless Beijing agrees to a currency revaluation, investors and economists are warning that either action threatens to upend this intricate economic and financial relationship, and could disrupt the U.S. economy and stock market, as well as global financial markets.
"The people who casually advocate Chinese revaluation don't understand how fragile this world is," says Andy Xie, Morgan Stanley's chief economist for Asia-Pacific.
To boost exports, China has kept its currency pegged to the dollar at what most analysts consider an artificially low rate. It then takes the proceeds of those sales and invests the money back in the U.S., mostly in Treasury bonds but also in American-made goods. That arrangement has helped to keep U.S. interest rates lower and to fuel the borrowing binge and housing boom in the U.S.
In other words, "China subsidizes the rest of the world by buying dear and selling cheap," Weijian Shan, a partner of Newbridge Capital in Hong Kong, said in a recent note.
The $18.5 billion bid that China's Cnooc Ltd., the oil giant that is 70% owned by the state, made for Unocal is subject to U.S. government approval. Yet the vast majority of corporate capital in the U.S.-China relationship still flows east. American companies invest tens of billions of dollars in China, and any backlash from the U.S. would likely hit their earnings.
Morgan Stanley's Mr. Xie estimates that the 27.5% tariff being considered by the U.S. Senate -- which enjoys strong support in the chamber -- would reduce the profits of the Standard & Poor's 500 companies by more than $50 billion, or as much as 8% of their total earnings. This could pressure the stock market.
"China has enabled American companies to cut cost and increase profits," Mr. Xie explains. "Only China has enabled Wal-Mart to produce fans at $2 and sell them in the U.S. for $40."
Yianos Kontopoulos, chief global foreign-exchange strategist for Merrill Lynch & Co., adds that much of the increase in trade flows between China and the U.S. "is little more than U.S.-owned companies shipping back their production to the home market."
If, for example, Dell Inc. sells a computer in the U.S. that was assembled in China, it will show up as contributing to the U.S. deficit with China. But does the deficit matter all that much if most of the profits go to Dell itself, and to Microsoft Corp. for the operating system and to Intel for the chip powering it? "The Chinese share in the value chain in the trade flows is quite low," Mr. Xie says.
Economists don't see much relief from a yuan revaluation, either. A modest revaluation of 3% to 5% would have a negligible effect on the ballooning U.S. trade deficit with China because Chinese wages are a fraction of those in the U.S., so goods made in China would remain much less expensive. A larger revaluation might address the trade deficit, but it also would spark inflation as the price of cheap, imported goods rises.
"Revaluation would end the Chinese fire sale," Phillip L. Swagel, a resident scholar at the American Enterprise Institute, wrote in policy paper last week. "Americans will pay more for everything from shoes to electronics."
Moreover, with China taking in fewer dollars after a revaluation, Beijing's demand for U.S. Treasury debt would likely diminish, forcing the U.S. to offer higher interest rates to attract new buyers. "A stronger yuan will mean not just steeper cost of financing of government debt but also higher payments for U.S. homeowners," Mr. Swagel wrote.
For John Taylor, chief investment officer at FX Concepts, a New York-based currency-management firm with $12 billion in assets, rising interest rates and inflation would represent the more benign outcome. He thinks any revaluation will only attract more "hot money" into China because speculators will view the initial move as the first in a series of revaluations and will try to pressure the government to move faster.
Other economists note that China has accounted for one-third of all global growth in recent years, boosting other Asian economies. If that growth slows as a result of rising trade tensions, Japan's fragile recovery will be jeopardized. Taiwan and South Korea also would be hurt.
Of course, there is some merit in concerns about China's powerful export thrust and the ability of other nations to absorb its prodigious output. China's trade with the rest of the world has swelled to an estimated $1.5 trillion this year from $281 billion in 1995. Its share of trade in its overall economic activity is twice that of the U.S. or Japan.
And if trade tensions escalate, other economies might benefit. A trade war with China could lead U.S. companies to other low-cost centers in the region -- leaving the trade balance still in the red, of course. For example, Mr. Kontopoulos suggests that if China does revalue, the Mexican peso may face upward pressure and be the beneficiary of inflows of direct foreign investment.
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