By Dominator Export Fireworks Co.

Will the Chinese Currency Revaluation Lead to Higher Costs and Lower Quality Fireworks?

 On July 21^st China ended its 11 year old policy of keeping its currency fixed against the US dollar.  The currency appreciated by 2% and a new policy allowing the currency to fluctuate by as much as 0.3% per day was adopted. 

 What this means to the fireworks industry is that Chinese factory costs, such as labor, and domestically produced chemicals and paper, have gone up by 2%.  

 Many economic experts believe that the 2% appreciation is much too small and that market forces may cause the currency’s value to change as much as 40% before the US’s trade imbalance could be significantly reduced.  Again, what this means to the fireworks trade is that China factory costs could go up by as much as 40%.

So, the two important questions to ask are, 1.) Will the Chinese currency appreciate again and if so by how much and 2.) How much of the higher costs that the Chinese factories incur will be passed onto US importers?

First, lets tackle the question of when and how much the Chinese currency is likely to move in the coming months.   Theoretically, if the currency moved to one end of its 0.3% trading range each day, we could see a 40% cost raise by mid-November, or right about when many importers are placing their 2006 orders.  However, if I were a betting man, I would put my money that this type of rapid change will not happen. 

Here is why. 

First, a 40% raise in currency value would have drastic effects on China’s economy and likely on the world economy.  Although the currency has been allowed to fluctuate, the Chinese government still very tightly controls it and they don’t have to allow it to move.  

Second, China’s massive purchase of US Treasury bonds has been a large force in keeping US interests rate low over the last several years.  The Chinese central bank has purchased US bonds to keep the Chinese currency fixed against the US dollar.   If a further revaluation were allowed to occur, fewer US Bonds would be need to bought and in order to make US Treasuries attractive, interest rates would need to go up.  This is typically bad news for the US economy, especially the booming housing market that has been fueled by low mortgage rates.

Finally, imagine that not only would the cost of Chinese Fireworks go up, but so would the majority of household goods that we have grown so accustomed to buying at rock bottom prices.  US manufactured goods would now be more comparable in price to imports, however the higher overall prices could lead to less consumer demand and this would be bad news for the US economy. 

Paul Craig Roberts, who was assistant Secretary of the Treasury under U.S. President Ronald Reagan, put it this way: “When China’s currency ceases to be undervalued, American shoppers in Wal-Mart, where 70 percent of the goods on the shelves are made in China, will think they are in Neiman Marcus. Price increases will cause a dramatic reduction in American real incomes. If this coincides with rising interest rates and a setback in the housing market, American consumers will experience the hardest times since the Great Depression”

In China, a reduction in exports would affect the manufacturing jobs of hundreds of millions of China’s growing middle class; neither the Chinese government nor the US government want to see these drastic changes to the world economy.   Therefore, both the US government and the Chinese government have haled the 2% appreciation as “an important first step”.   This serves the political needs of both the US government and the Chinese government.   

However, if 2% is the extent of the revaluation, this will have almost no material impact on the trade deficit or bringing back American manufacturing from China.  Therefore, it won’t be long before US manufacturers and labor unions are again pressuring the US government to put pressure China.   Thus, the only conclusion that can be drawn from all of this, is that over the next several years there will be continued pressure Chinese manufacturing costs to rise and that there will be significant uncertainty over by just how much and when. 

So, given that costs are likely to rise in China, what does that mean for US fireworks importers that have come to depend upon the low costs coming out of China?  If costs in the Chinese factories rise, will they be passed onto US importers?  With over 1,500 fireworks factories in Liu Yang alone, the competition among factories is fierce.  However, contrary to popular belief, Chinese factories cannot operate below cost any longer.  State reform of the fireworks industry is complete and there is only one state run factory left in the country (the Temple factory in Beijing that manufactures the fireworks for Beijing’s huge notational day celebration).  All other factories have been privatized and can only survive if they are profitable.   Competition among the factories is fierce and US importers have enjoyed a period of declining fireworks costs and raising quality over the last several years.  However, profits are low in the factories and many are running at a very high efficiency already.  If costs were to increase by even a few percentage points, let alone 40%, the factories would not be able to absorb these increases and continue to pay the bills.  Therefore, if and when the Chinese currency has further appreciation, it is very likely that we will see these costs largely passed onto importers.  If importers insist on keeping the same low prices then the Chinese will be forced to make up for the higher cost by lowering the quality of the product. 

In summary, international trade has always been a complicated business.  In recent years, US fireworks importers have enjoyed a favorable environment with fixed currency rates and the benefits of privatization of the Chinese fireworks industry.  However, in the free market, there are no free rides and my prediction is that the importation of fireworks is about to get a lot more challenging.  Currency uncertainty will require importers to have a working knowledge of the international currency markets or they risk getting burned significantly if they make the wrong assumption in their contracts.  Higher costs to the Chinese will likely trigger the desperate act of lowering quality to try to keep up with US importers low price requirements.   The industry will have to be very careful not allow reductions in quality, to cause a loss of any of the hard earned ground that it has gained with US regulators, insurance companies and public opinion.  Therefore, choosing the right importing partner will be more important than ever for US Fireworks companies.

See other articles of interest:

End of the golden age of importing

China Cost Increases

Living the dream in Liuyang

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