Newsweek Blog 2007-12-18 23:49:42The “China price” is heading North -- at least when it comes to specialized hosiery. According to press reports, Wal-Mart is once again buying from Langsha, a top athletic-sock maker based in Zhejiang province, after refusing to pay the higher prices the footwear giant was demanding in August. (Langsha would not comment; a Wal-Mart spokesman said he was unaware of the Langsha contract which he says may have been negotiated with a sub-contractor.) It was Wal-Mart that so effectively used its vast market share to squeeze suppliers in the first place. So if the uber-retailer is backing off, dirt-cheap Chinese goods – a key factor in keeping inflation at bay worldwide - may be a thing of the past. Or not. Market leaders like Langsha may be able to demand modest price increases, but most Chinese manufacturers are still at the mercy of overseas buyers and a growing number of them are relocating their production facilities abroad to escape withering inflation at home. China’s economy is growing so fast that even its abundant labor force isn’t large enough to keep up with demand. Wages are rising along with inflation – October’s 6.5 percent increase in China’s consumer price index was the largest monthly hike since 1997 – a byproduct of speculative funds infiltrating the economy in anticipation of a further appreciation of the Chinese yuan. Beijing has already allowed its currency to rise against the US dollar by 6 percent or so over the last year. Further increases would benefit Chinese companies which import raw materials and finished goods – airlines, for example, which buy foreign-made aircraft, or utilities companies, which import fuel. A more valuable currency would also make US assets, already cheap due to the weak dollar, look increasingly appetizing to cash-rich Chinese corporations and investors. But an upward adjustment in the yuan’s value would hurt most of China’s exporters, which rely on exchange rates that make their products affordable abroad, and nearly all its farmers, who fear a stronger currency would enable local consumers to import more agricultural goods at their expense. And as the rump of China’s economic growth is still generated by export sales, it is politically unpalatable for most of the country’s leaders to promote a stronger yuan. Anyone who openly supports yuan appreciation,” says Teng Binsheng, a professor at Beijing’s Cheung Kong Graduate School of Business, “would be public enemy No. 1. Not everyone is mute, however. In the December 3rd edition of The Economic Observer, economist Zhou Qiren argued that because so much of the country’s inflation is generated by speculative investment in local assets, the government should give the punters what they want in one sharp adjustment and get it over with. A strong yuan, he wrote, would also reorient the Chinese economy away from exports while encouraging investors and businesses to develop neglected markets at home. It was a surge in exports of cereal products, argues Zhao, that contributed to this year’s spike in pork prices. “So long as private individuals or government officials see an undervalued yuan, they will focus on exports,” Zhou wrote. “And that means a widening trade surplus, over-liquidity and spiraling inflation.” Zhou has an ally in US Treasury Secretary Henry Paulson, who was in Beijing last week to lead the US side in the Strategic Economic Dialogue, a biannual round of Sino-US discussions. Paulson, Washington’s point man in its relationship with Beijing, has been urging China to let the yuan strengthen, both to ease inflationary pressure in China and to ease its trade friction with the US. He returned to the US with only symbolic concessions and no movement at all on foreign exchange issues. While neither Zhou nor Paulson may get what they want anytime soon, the increasingly complex debate over the yuan’s fate illustrates how quickly the world’s fastest growing economy is evolving. Not long ago, China was known for importing jobs from the developed world and exporting capital to the debt-laden US economy by purchasing its sovereign debt. Now the country is exporting low-margin work to developing countries in Southeast Asia and Africa while importing a torrent of hot money – much of it from American hedge funds and private equity specialists betting on a stronger yuan. Given the extraordinary pressures now squeezing the world’s fastest growing economy, it’s looking more and more like the smart wager.