The yuan, the dollar, and the future
04/01/2005
China is on the verge of becoming the world’s largest consumer of semiconductor products, but several dark sides of this economic boom exist, and most have been examined in detail. But one issue has not received the attention it deserves, and that’s the fixed currency exchange rate that ties the value of the Chinese yuan directly to the US dollar.
A quick primer on exchange rates: In a floating exchange rate, the value (price) of a currency automatically adjusts to supply and demand for that currency. A floating exchange rate acts as a sort of “shock absorber” to offset economic imbalances and instability, both domestic and international. In a fixed exchange rate, a currency’s value is tied directly to some other currency (usually the US dollar), and no automatic shock absorber exists. Fixed exchange rates usually create an artificially high or low value of the currency that is pegged to the dollar.
VLSI Research CEO and president Dan Hutcheson raised the danger of China’s fixed-rate exchange policy earlier this year at Semi’s annual Industry Strategy Symposium (ISS). “The China fixed exchange rate is something I think most people are overlooking,” said Hutcheson. “Most international governments are trying to get them to break this. It will have [a] major impact on our economy as well as other Western economies.”
The immediate problem with China’s fixed exchanged rate is that it has created an artificially low value for the yuan, which makes Chinese exports to the US and other countries cheaper, in turn fueling an export advantage for Chinese products and a significant trade imbalance with China. In the short term, the US economy and, perhaps to a greater degree, European economies are damaged by this artificially created trade deficit. China benefits in the form of new jobs, increased global market share, and additional investment by foreign companies.
Longer-term, a more dangerous economic situation looms. “Eventually, [the fixed exchange rate] will create huge problems for China,” said Hutcheson. “[China] will go through hyperinflation,” and its economy will “blow up. The same thing happened to Japan in the ‘80s,” he added, when Japan finally changed its fixed-rate exchange policy, adopted after World War II.
But some economists caution strongly that an abrupt rise in the value of the yuan might destabilize the Chinese economy and, potentially, even the global economy. In addition to the situation in Japan, sudden shifts from a fixed exchange rate have produced major financial problems in the past in Indonesia, Thailand, and South Korea.
At a February meeting in London of the Group of Seven Industrialized Countries, commonly known as the G-7, US and European leaders pressured China to abandon its fixed-rate exchange policy and revalue the yuan, but to no avail. China officials argued that more time was needed to reform the country’s financial system.
The most likely scenario is that China will, sometime fairly soon, allow the yuan to float within a specified range of values, or “corridor,” as economists call it. This range would broaden over time, as China’s financial institutions develop and its businesses learn how to deal with frequent changes in currency values.
The last thing the global economy and the semiconductor industry need is another financial crisis in Asia, and a crisis in the gigantic but developing market of China could make past predicaments seem tame in comparison. Economic issues usually bore technologists - and people in many other professions, for that matter - but economic conditions obviously help create or stifle the environment that’s needed for technology and technologists to thrive. Let’s hope that the world’s political and financial leaders have the foresight and courage to help China and its huge semiconductor market develop in a way that is best for everybody.
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Kevin R. Fitzgerald
Editor-in-Chief