William Pesek: Why Paulson faces disappointment in China

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By William Pesek
Bloomberg News Service
Friday, December 1, 2006

http://www.bloomberg.com/apps/news?pid=20601039&sid=aNlktVN07lps&refer=h...

If imitation is the highest form of flattery, then perhaps piracy is a globalization-age sign that you have made it in the world.

John Chan, a Shanghai-based business consultant, knows something about the phenomenon. Early this year, a businessman in Shanghai asked Chan to sign a copy of his 2003 book, "China Streetsmart." The 42-year-old was flabbergasted to see it was a pirated copy -- one made in China and bought in the U.S.

"Of course, now I can laugh about it," Chan told me in Beijing recently. "But it's a real wake-up call about just how far counterfeiters will go to make money and how big their operations are getting."

Step into a Beijing shopping center and you will be surrounded by names such as Louis Vuitton, Tiffany, Sony, Gucci, Nike, Microsoft, Rolex, Burberry -- you name it. Chances are that many are fakes, and very good ones at that. It makes you wonder how luxury-goods, sports, technology, and publishing companies will make money in the world's most-promising economy.

There's a reason that China doesn't clamp down aggressively on intellectual-property-rights violators: their operations, for better or worse, create jobs. The untold thousands of people employed by counterfeiters aren't likely to gather in Tiananmen Square and challenge the Communist Party.

While piracy and currency policy seem worlds apart, such logic applies to the yuan too. All the excitement about China allowing its currency to rise versus the dollar ignores a basic fact: China's main focus is on creating millions of jobs, and that augers against a sharp rise in the yuan.

The yuan has been edging higher and will continue to do so before a Dec. 14-15 visit to China by U.S. Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke. This week, the yuan rose to its highest level since China ended its decade-old link with the U.S. currency in July 2005. The increase in value occurred after Paulson said yuan gains will help resolve "tension" in trade relations.

Currency traders' reaction to so ambiguous and obvious a statement shows how much they are betting on Paulson's and Bernanke's visit. Yet markets are forgetting how good China has become at appearing to let the yuan rise, while giving up virtually nothing.

China showed what it could do when it scrapped its dollar peg. Its teensy-weensy 2.1 percent revaluation elated global heads of state, who issued press releases about it.

It was sheer brilliance. China's baby step convinced the world that the Asian country was making a major accommodation. And since then, nothing. While China is tolerating a somewhat stronger yuan, gains haven't been anything close to what economists and politicians had hoped.

There are two basic reasons that Asia's No. 2 economy isn't about to let the yuan shoot higher.

One, it would impede job creation in the world's most-populous nation at a time when the gap between extremely rich and extremely poor is growing.

Two, it may be too late.

"Central to China's growth and economic modernization is to maintain their currency at a level that allows them to export ever more manufactured goods to the developed world," says Donald Straszheim, vice chairman of Roth Capital Partners LLC in Newport Beach, California. As such, he sees "zero chance that they will do another discreet revaluation again, like on July 21, 2005."

It's a stability issue. China's efforts to maintain peace while 1.3 billion people aim to grow richer by the day are focused on offering an ever-increasing number of employment opportunities. At this stage of China's development, that means jobs supported by exports.

"There's no way manufacturing, trade, industrialization, infrastructure, and migration from rural to urban could have worked" without a weak currency, Straszheim says. "These are all the core of their 9.7 percent growth from 1978 to 2005."

China also missed its best opportunities to boost the yuan. Now that growth in the U.S. is expected to slow and Japan has recovered with more of a whimper than a roar, it's hardly an ideal time for China to risk damaging its export industries. There's also increasing pressure on China to begin addressing its worsening pollution problems.

Nor is it in the world's interest to see Chinese growth decline in 2007. With the U.S. set to slow and Europe and Japan expanding about 2 percent, the global economy needs the rapid growth emanating from China, India, and Southeast Asia.

"In the emerging countries, conditions are pretty buoyant," Jean-Philippe Cotis, chief economist at the Paris- based Organization for Economic Cooperation and Development, said on Nov. 28. "These growth rates are pretty strong and should support the world economy."

Besides, a 20 percent or even 40 percent increase in the yuan's value wouldn't change U.S. consumers' passion for bargains or low-cost goods. It also wouldn't reverse massive U.S. budget and current-account deficits.

The so-called Plaza Accord of 1985 sharply weakened the dollar versus the yen. It did little to improve the U.S.'s balance of payments, yet it contributed to the asset bubbles that led to Japan's lost decade in the 1990s. The unintended consequences of Chinese revaluations could be even more extreme.

U.S. politicians will continue to find a convenient scapegoat -- and punching bag -- in China. That doesn't mean traders should be expecting big steps on the nation's currency.

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William Pesek is a Bloomberg News columnist.

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