The Asian factor

The economic rise of China continues to change the face of Atlanta's business scene

Jeffrey Rosensweig

January 1, 2007

Executives in Atlanta undoubtedly are aware of increased foreign influences. Such influences include new competition, growing markets, sources of components or supplies and pressures to consider outsourcing production. This can be done through foreign vendors or building new facilities abroad.

Of course Asia, particularly China, exerts the major new impulses. Signaling one aspect – the increased competition from abroad – the United States has once again suffered a new world record deficit on trade in goods (manufactures and commodities). The same sad record is true for the overall deficit on goods and services, although the United States consistently maintains a small surplus on services. This is good for Atlanta – a service industry superstar.

The medicine which standard international business theory indicates should help cure a trade deficit is a lower U.S. Dollar (US$) value relative to other major currencies. This depreciated exchange rate for the US$ makes U.S. products relatively cheaper versus foreign production. But this is not yet having a noticeable impact on the deficit.

Nonetheless, there is a positive trend if we look deeper – the US$ becoming cheaper vs. many currencies is helping the United States achieve successive record highs on monthly exports.

Why has the US$ lost a significant amount of value, thus making U.S. production relatively cheaper, compared to the start of 2002?

First, the U.S. stock market bubble burst, so foreigners sold their U.S. stocks and dumped US$ to bring their wealth back home. Second, crises at Enron, Worldcom, Tyco, etc., led to disrespect for the safety and soundness of the U.S. financial system. Third, the accumulating record U.S. trade deficits made foreign exchange market participants fear that the United States could not compete, and therefore was building up an unsustainable foreign debt.

Key examples of the US$ falling significantly in value include its exchange rate versus the currencies of major trading partners: the Euro, the Canadian and Australian Dollars and the British Pound. These exchange rate movements make U.S. exports cheaper to potential purchasers in these nations. This impact, along with increased demand due to a few years of good economic growth worldwide, largely accounts for the good news – the progression of record U.S. export sales.

In both its appetite for commodities and its flooding of world markets with manufactured exports, the rise of China has changed the face of business forever.

The standard theory asserts that major foreign currencies rising in value should make their foreign products relatively expensive in the U.S. market. After a time lag to build up alternative U.S. domestic suppliers, U.S. imports should be curtailed. Along with the rise in exports, this downward import impact should eventually shrink the trade deficit.

Surging U.S. imports

Given the above, why do U.S. imports keep surging, outpacing the rise in exports and thus resulting in record trade deficits?

There are at least three reasons. First, the good news: imports can rise due to a nation's increased overall demand, by both firms and households, owing to economic and wealth growth. Since 2002, the United States has enjoyed good growth in the economy, jobs and wealth. Real estate, bonds and stocks, including mutual funds, have all yielded good returns. This demand impact is clear in the many jobs created in Atlanta since the tough times in 2001-2002.

Second, the overall import bill can rise due to increased worldwide prices for key commodities that a nation needs, such as energy and iron ore. Prices of such crucial commodities have risen dramatically over the past few years. Consumers and producing firms in Atlanta sure know this to be true.

Third, imports can rise if large nations increase their productivity while having low wages. Wages in such nations are even lower relative to those in the United States if their currencies are cheap in terms of the US$. It is clearly the case that China and some other large economies in Asia still have cheap currencies despite rapidly rising productivity and quality.

Why are their exchange rates still cheap when the currency values in other key U.S. trading partners, such as Canada and Europe, have increased so much?

The answer is revealed in the accompanying chart (please see Foreign reserves held by Asian central banks accumulate rapidly on page 30). A number of Asian nations that have emerged as big global trade players are accumulating massive reserves of foreign currencies. This means that their central banks are intervening in the foreign exchange market and buying currencies foreign to their own, especially the US$. They do this to support the exchange value of the US$, printing their own money to supply it to the market and mopping up excess US$, in order to keep their own exchange rates low.

The graph illustrates that many Asian nations have added tremendously to their stock of foreign exchange reserves in the years since 2002. This intervention held their currencies relatively cheap, contrary to the exchange rate movements in Canada and Europe that made U.S. producers better able to compete with their producers.

Most noteworthy are the truly gargantuan foreign exchange reserves held by both China and Japan. Japan's continued purchases of US$ helped support the value of the US$ versus the Japanese Yen. This stands in stark contrast to the hands-off, let-the-free-markets-prevail European and Canadian behavior.

A key implication to analyze is the truly remarkable trend graphed – the jump in China's foreign reserves, even exceeding those that Japan has been accumulating for decades. China's foreign currency reserves passed the world record threshold of a trillion dollars this past October.

The China Factor

What is the motivation behind China's massive intervention, whereby its central bank purchases US$ and sells Chinese Yuan in the currency market, in order to keep its currency from becoming less cheap (ignoring the small currency value gains China started allowing last summer)?

This intervention renders China's exports of an increasing range of products highly attractive. This effect is amplified as foreign direct investment pours in, adding to technology, training and quality and boosting productivity in China and its global competitiveness.

The second chart (please see China will soon become the world's leading exporter of goods on this page) shows the success of this strategy and the truly global impact of it when combined with the world-leading labor force size and the beneficial impacts of the hard work and high-saving behavior of the Chinese. China will soon be the largest exporter of goods in the world. This may not surprise some readers faced daily with the impact of China; however, this is an amazing rise from near zero exports until China began opening to the world in 1979.

Note that Germany, known for precision cars and equipment, is still the largest exporter of goods. The United States is second, but China is on such a rapid growth path that it is forecast to almost catch up to the United States this year, and then pass the United States in 2008. Soon afterwards, China is expected to pass Germany and total more goods exports than any other nation.

Maintaining some U.S. pride, of course, the United States is expected to exceed China in per capita exports of goods. Also, the United States will continue to lead in exports of services (travel, financial, education, etc.).

For Atlanta, the implications are a mixed bag. Firms investing heavily in China, such as Coca-Cola, will gain. United Parcel Service (UPS), the world leader in transportation services, has a sophisticated China strategy and will gain as China rises in the global trade rankings. The Home Depot becomes more profitable as it increases its sources of Chinese products. Conversely, Atlanta area manufacturing firms are hurt by the still-cheap currencies in Asia.

For Atlantans, the conclusion is inescapable: in both its appetite for commodities and its flooding of world markets with manufactured exports, the rise of China has changed the face of business forever.

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