Dominator Export Fireworks Co.
the Chinese Currency Revaluation Lead to Higher Costs and Lower Quality
July 21st 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%.
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
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
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
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
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.
other articles of interest:
of the golden age of importing
the dream in Liuyang