Hungry Dragon could go black

World Of Finance by Vijaya Sai.M

It seems that nothing can stop the relentless rise of China's export machine. Whether that counts as good news depends on where you live and what you're invested in.Commodity investors were among those cheering yesterday as Beijing surprised world markets with the news that its exports had jumped nearly 18% in December from a year earlier.The reason for the cheering was that Chinese imports jumped even more than exports. They were up nearly 56% as the Asian nation imported record or near-record amounts of iron ore and crude oil.

China's growing appetite for commodities is bullish for companies that produce raw materials ranging from soybeans to copper. It's also likely to provide a boost to currencies such as the loonie and the Australian dollar that represent commodity-producing economies.

But China's swelling exports are distorting world trade in ways that could have nasty consequences, including the possibility of an abrupt letdown for commodity investors.

Tensions are already growing with the United States, which objects to Beijing's policy of pegging its currency to the U.S. dollar at an artificially low exchange rate.

The fixed exchange rate gives China's factories a nearly unbeatable price advantage against manufacturers in other countries. The price advantage has grown even larger after the U.S. dollar - and thus the Chinese yuan - fell sharply against other major currencies last year.

For the United States, locked in a jobless downturn, the steady flow of manufacturing jobs to China seems like a never-ending series of slaps in the face. Cheap Chinese goods also hit hard at other nations, such as Japan and Germany, which depend heavily upon manufactured exports.

But China's foreign-exchange policy poses dangers for its own economy, too. By keeping its currency at an artificially low level, China is increasing the cost of its imports from the rest of the world. This raises its domestic prices and fuels its domestic inflation.

As Chinese investors look for ways to protect their purchasing power against inflation, they're stockpiling commodities far in excess of actual need. The danger is that prices for these stockpiled commodities, such as copper and nickel, may plunge when the artificial demand from Chinese speculators reaches a limit.

"China is simultaneously inflating itself and deflating the rest of the word," says Charles Dumas of Lombard Street Research in London. His data show a swooping Chinese recovery that stands in stark contrast to the rest of the world. While exports from Japan and Germany are still running far below their pre-crash levels of mid-2008, Chinese exports have not only made up all their lost ground, but are setting new peaks.

Rapid Chinese growth is having two diametrically opposed effects. On the one hand, the wave of low-cost Chinese exports is bringing down prices for manufactured goods in the rest of the world. On the other hand, China's booming imports of raw materials appear to be a big reason behind the recent run-up in prices for oil and metals.

Dumas says Chinese investors have stockpiled oil and metals far in excess of likely usage. "When storage space runs out, commodity ‘investors' had better remember to be short," he warns.

The most hopeful scenario is that Beijing will see the recent surge in exports as reason to let its currency appreciate and commodity markets ease back gradually to more realistic levels. But Beijing seems reluctant to let the yuan float higher because of its need to create jobs for its massive population.

If the world economy makes a rapid recovery in 2010, China's fixed exchange rate may prove to be just a minor irritant. But if jobless numbers remain high, politicians in Europe and the United States could decide to erect trade barriers to Chinese exports.

They have good reason to act. Paul Krugman, the Nobel-winning economist, recently calculated that China's trade surplus with the rest of the world is dragging down gross world product by about 1.4 percentage points a year. He estimates that China's policies have cost the United States about 1.4 million jobs.

An increasing number of people believe that China will yield to pressure and let its currency rise this year. Speculators are already driving up the price of several Asian currencies on the belief that there will be a broad appreciation of those currencies against the dollar.

Canada could benefit as well. "There are ... positives for the Canadian economy if the yuan is allowed to appreciate," says Benjamin Reitzes, an economist with BMO Capital Markets. "Not only will Canadian exporters be relatively more competitive in China, but less upward pressure on the loonie would be a boon to those competing in the U.S. as well."