MONDAY JUNE 21, 2010

Currency Politics

This weekend the People's Bank of China announced that it was dropping the yuan's peg to the dollar in favor of a more flexible exchange rate policy.  The markets opened strongly on this news, largely because the action may have the benefit of avoiding a trade war.  The Chinese are taking this action just a week  before the next G20 meeting, hoping to appease the politicians in Washington calling for punitive tariffs.

In theory, the U.S. is losing manufacturing jobs to China because the yuan in undervalued.  Therefore, the politicians claim that a stronger yuan will raise the cost of Chinese imports (raise your hand if you want to pay more for your electronic gadgets), which in turn will make our domestically produced products more attractive.  U.S. manufacturers will respond to this increase in demand be hiring more people.  Sounds great, in theory.

In reality, global manufacturers have more options than a binomial China or the US.  If the cost of manufacturing increases due to currency politics, than the manufacturers will look to other low labor cost countries like Vietnam, India or Bangladesh.  In addition, the amount of labor cost associated with production in a highly sought products like smart phones, computers, video consoles and flat screen TVs is relatively small.  Perhaps the labor cost of assembling an I-Phone is 10% of the total cost.  Is a 10% increase in labor costs from currency policy going to shift the cost equation significantly?  Will these manufacturing jobs come running back to the U.S.?  Wishful thinking if you ask me. What are the real likely effects of this change in policy?  Hopefully it can tame the trade war rhetoric, as no one wins in a trade war.  More likely, it will weaken the value of the U.S. dollar which in turn will cause commodity prices to increase and interest rates to rise in the U.S.

So let's sum this up.  I get to pay more for my imported products, commodities like oil and copper will become more expensive and interest rates will rise.  All to promote the Washington fantasy that we are protecting US jobs.  Sounds like a raw deal to me!

POSTED AT 1899-12-30 10:03:00.0

KEN ENTENMANN, CFA
SENIOR VICE PRESIDENT AND
THE DIRECTOR OF INVESTMENT MANAGEMENT SERVICES

Ken is a Senior Vice President and the Director of the Trust and Investment Services at Alliance Bank, N.A. He has 23 years of investment experience and oversees the management of assets totaling $1 billion. He holds a B.S. in Applied Economics and Business Management from Cornell University and an M.B.A. from the William E. Simon Graduate School of Business Administration at the University of Rochester. He has also earned his Chartered Financial Analyst designation. He is a member of the Executive Committee of the Trust Division of the New York Banker's Association. He is also a director of the Central New York Community Foundation.

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