Will a Rising Yuan Mean Rising Prices?

Tech manufacturers are benefiting from China's low-value yuan, but they may skip town if the currency continues to rise.

Policymakers on both sides of the Atlantic are putting pressure on China to stop artificially propping up its currency.

While the underlying assumption is that a strong yuan will help the economies of those developed nations, those policymakers should be wary of an old Chinese proverb: be careful what you wish for.

While U.S. lawmakers claim that an undervalued Chinese currency has created a trade gap between the two nations, the yuans comparatively low value has actually benefited technology manufacturers, many of which use Chinas high-density manufacturing centers to produce low-cost goods for overseas markets.

But while some tech-sector companies may be squeezed by a stronger yuan, consumers are unlikely to feel a pinch.

By mid-July, the yuan had closed at its highest rate against the U.S. dollar since China ended its fixed dollar exchange rate. The currency, currently at 7.5620 against the dollar, has already risen 9.5 percent since July 2005, and may strengthen to 7.47 by the end of this year.

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That slow, yet inexorable, rise will increase the cost of doing business in China, ostensibly curbing exports from the country. According to some experts, the higher currency valuation will also galvanize companies into looking for cheaper manufacturing bases in neighboring nations.

The result: Potential slowdowns in the supply chain, which could translate to higher prices in overseas markets.

"If companies are forced to relocate due to a rising cost of business in China, there could be a modest delay along the supply chain, possibly for up to a year" said Catherine L. Mann, senior fellow at the Peterson Institute for International Economics.

The delay would be caused by relocating, building or finding new factories, and setting up infrastructure— ports, delivery schedules, a new workforce—to accommodate the new processes.

"The biggest winners in this scenario would be Vietnam, India, Sri Lanka, and some African countries, all of which are trying to attract business with lower wage workers," said Carl Steidtmann, chief economist and director of consumer business at Deloitte Consulting.

But China still has one advantage those other countries dont: infrastructure. Chinas competitors cant support the same critical mass of manufacturing centers, and thus cant deliver goods as quickly. Any cost advantage a company gained by leaving China could be offset by a slower supply chain.

"As with everything, you can have something cheap or good or quickly," Steidtmann said. "You can only have two."

Another reason companies may be reticent to leave is that specific areas of China—including Suzhou province in East China and Shenzhen province in South China—are home to key parts of the electronics supply chain. Most of the firms that do business with Western businesses there are Taiwanese.

According to Arthur Arthur Kroeber, managing director and head of research at the consulting firm Dragonomics, based in Hong Kong, those networks cannot be moved piecemeal but need to relocate together, much like they moved from Taiwan to China from 1995 through 2000.

"So until there is overwhelming pressure to move they are likely to stay put," Kroeber said. "Furthermore, for linguistic, cultural and other reasons, I suspect Taiwanese businessmen will try to figure out ways of staying in China rather than moving to less familiar places like Vietnam."

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A flight from China would also buck a prevailing trend that sees increasing amounts of the electronics supply chain moving into the country, Kroeber said.

"The net tech trade balance of foreign invested enterprises went from a negligible $600 million in 2002 to $34 billion in 2005," he said. "This is a very powerful trend, supported by the advantages China offers in terms of economies of scale and density of supply networks, and I find it hard to believe that this trend could be overwhelmed by a very modest currency appreciation."

For now those modest increases are contributing only slightly to the cost of business in China. Consumers in the United States are unlikely to see any changes in retail prices.

"No matter what the [yuans] rise every technology companys number one objective is to maintain its market position in terms of final price to the consumer inside the U.S.," said the Peterson Institutes Mann. "The companies will take a hit to their profit margin before they increase prices."

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