China's Yuan Adjustment - Aug 2015

China's Yuan Adjusment: What it Means for Reshoring and Trade

Countless articles have been written about reshoring and nearshoring of production back to North America. The recent devaluation of the Chinese yuan or according to Chinese government officials, allowing the value of the currency to be "more market-driven gives us an opportunity to talk about what reshoring/nearshoring really means relative to actual trade flows.

First, we must remember that nearly 85% of goods and services consumed in the U.S. are produced here. Including those produced in the NAFTA region, this number rises to 90%. Compare that to China's average of 81% of goods and services produced domestically, and approximately 70% worldwide. (World Bank data.) As much as we talk about a global economy, it is still very localized. Any discussion regarding production relocation only involves a small percentage of goods.

The following are a few statistics that put the recent adjustment of the yuan into perspective.

  • According to Bank of International Settlement (BIS) statistics, the yuan's value has appreciated by 34% since 2008.
  • Chinas current account surplus, or the amount of exports versus imports, has dropped from 9.2% in 2008 to just 2% of their economy. For 2015, this gives them the 29th highest current account surplus.
  • Since 2008, the growth of imports into China from the rest of the world has averaged a little under 10% per year. The days of huge trade surpluses are a thing of the past.
  • Chinese goods and services imported into the U.S. represent only 3% of our GDP.

Even with the recent adjustment in the yuan, underlying fundamentals have not changed neither from a cost of production perspective, nor from the standpoint of a Chinese political imperative.

Barring government-induced market inefficiencies, production will continue to flow to where it is most efficient. (Yes, Adam Smith's spirit is alive and well.) Items that are produced with relatively non-skilled labor, such as clothing, will continue to shift to countries with the lowest labor cost such as Bangladesh, and more frequently, African countries, given their proximity to U.S. and European consumer markets. China will continue to move up the value chain, especially in producing goods whose manufacture is not easily automatable, but requires skilled labor. At the same time, the U.S. will continue to dominate industries requiring sophisticated and constantly changing intellectual property, as well as industries that can be efficiently automated. Contrary to popular belief about the demise of American manufacturing, U.S. industrial output has doubled over the past 33 years.

From a political perspective, President Xi and the Chinese government understand that they must continue the rapid growth of their economy. Because the Chinese people have come to expect a steady standard-of-living increase, a slowdown would cast a shadow over the legitimacy of government policies. In addition to encouraging Chinese citizens to consume more (which hasnt been particularly successful), the Chinese government will need to lower its citizens' long-term growth expectations, while modifying underlying fundamentals that are driving huge amounts of money out of the country. A large drop in the value of yuan is unlikely, as it will not help any of these fundamental issues and in many ways will only worsen them.

The cost of transportation (which is largely driven by the price of fuel), domestic policies towards business, as well as products' time-to-market requirements, will all continue to be huge drivers in the decision to reshore. Short-term changes in the value of a currency will not change these underlying fundamentals.