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Recent moves on Capitol Hill may force CFOs to carefully consider what will help them versus hurt them.
Janet Kersnar, CFO Magazine
November 1, 2010
A flurry of congressional activity regarding foreign trade has more than a few CFOs on edge, and for good reason. On the one hand, they understand why Washington would seek to improve current economic conditions by getting tough on major trading partners, including China, whose protectionist policies hamper U.S. exports.
On the other hand, even if their companies have benefited from this year's modest recovery, CFOs know that they still face a challenging 2011 and 2012, a period during which their biggest growth prospects will not lie at home but overseas — including those countries that may be irked by recent U.S. trade actions. As a result, many finance executives are concerned that the current discussions in Washington, regardless of whether any bills being promoted are actually passed, will spark a trade war.
Most of the attention is on China. Last year it replaced Germany as the world's biggest exporter, and its rise to the top can be traced not only to its status as the locus of low-cost manufacturing but also to its efforts to keep its currency artificially low against the dollar. The latter action has helped China's exports thrive, to the point where it now sells far more than it buys, creating a burgeoning imbalance with its main trading partners, including the United States and the European Union.
China's critics had welcomed its announcement in June that the yuan would be allowed to float more freely. But disappointment soon followed, as the currency strengthened only a few percentage points, as opposed to the 10% to 30% jump that many U.S. companies hoped for. Meanwhile, China's trade surplus continues to rise year over year; in August it soared to $20 billion from the prior period's $16 billion.
Combine that trend with the recession and a potentially power-altering midterm election and many experts say the stage is set for an intersection of politics and business that will not only generate plenty of rhetoric, but perhaps some misguided policies.
As those experts note, trade deficits and surpluses are an imperfect measure of how goods flow between countries. Beyond the statistics, what often gets overlooked is the impact of globalization and the intertwined nature of goods traded between countries. Economists point out, for example, that many of China's exports come from U.S.-owned companies or other multinationals.
Meanwhile, companies outside China need China as much as it needs them. Research from two European academics — Joseph Francois of Johannes Kepler University in Linz, Austria, and Simon J. Evenett of University of St. Gallen, Switzerland — underscores the importance of imports to the competitiveness of U.S. firms. They found that most imports from China into the United States aren't the inexpensive jeans, T-shirts, and toys that American consumers buy from their local Wal-Marts, but, in fact, unfinished parts and components that U.S. industries use to make high-value goods.
"Send China a Message"
The recent activity in Washington began with two key votes in September — first by the House Ways and Means Committee followed by the full House of Representatives — in favor of imposing tariff duties on countries that have artificially undervalued currencies. Whether or not the bill is passed by the Senate and approved by President Obama remains to be seen, but should the effort succeed in some form, its impact on U.S. companies will vary widely depending on where a company sits in global supply chains.
For Cass Johnson, president of the National Council of Textile Organizations (NCTO), the legislation, if passed, would be a positive development. "From the perspective of our industry, our concern is that China's prices for its manufactured goods are artificially low," he says.
According to the NCTO, China's share of the U.S. apparel market is now at 40%, up from virtually zero in 2000. Meanwhile, over that same period, the number of U.S. textile employees has dropped to 412,000 from more than one million. More than 500 textile plants in the United States have closed over the past 10 years.
And while the U.S. textile sector — which exported more than $10 billion worth of goods in 2009 — has been adding more jobs and reopening plants recently, Johnson says it is still struggling to compete against Chinese goods — which are unfairly cheap because of the low yuan, he argues.
As for the argument that a big hike in the value of the yuan will trigger inflation in the United States as Chinese goods become substantially more expensive, he says, "Inflation isn't our big concern, unemployment is." With overall unemployment in the United States hovering stubbornly around 10%, "we're just hoping for some relief, and hopefully [the bills] will send China a message," he says.
Others say that any message sent by legislation risks being the wrong one. The U.S.-China Business Council (USCBC), a group of some 250 companies promoting trade between the two countries, calls Washington's recent bills "counterproductive." Its president, John Frisbie, said in recent testimony before the House Ways and Means Committee, "USCBC believes that China's exchange rate should better reflect market influences from trade flows and supports effective actions to get to that goal. Counterproductive tariff legislation…will do more harm than good."
One company joining USCBC's lobbying efforts is Caterpillar. The $32 billion firm manufactures a vast range of construction and mining equipment worldwide, and has eight factories in China alone. But it is also a big exporter into Asia-Pacific, which accounted for about one-fourth of the $10.4 billion of goods its U.S. plants sold overseas in 2009. Any trade friction would hurt. As William Lane, its government-relations director, stated before the House Ways and Means vote, "Some in Congress want to start a trade war and undermine our efforts to sell to our fastest-growing export market."
Multinational companies aren't the only ones voicing concern. Another USCBC member is Chindex International, a U.S.-based, $171 million Nasdaq-listed company that has been exporting medical equipment to China for the past 20 years, and which also operates a network of private hospitals in major cities in China. CEO Roberta Lipson calls the recent votes in Washington "misguided." She says, "A 10% or 15% increase in the yuan's value is not the solution to [the U.S.'s] economic problems. Other countries have even lower costs than China." A better strategy, she reckons, is to convince China to lower its own duties "so that there is a more level playing field."
And what can executives at other companies do? "We've been encouraging our [USCBC] membership to educate their rank-and-file about the importance of healthy trade with China," she says.
Jeopardizing U.S.-China trade could indeed have big repercussions worldwide. Economist Andy Xie recently noted that total U.S. trade in goods for this year "should be a touch above $3 trillion," while China's trade will be $2.9 trillion. "Given these enormous sizes, a trade war is inconceivable. Even a significant risk of such an outcome would lead to stock markets collapsing around the world."
Tit for Tat
In any case, "will a stronger yuan get rid of the U.S. [trade] surplus? No way," says Evenett of the University of St. Gallen. "Focusing on the currency is wrong." Like Lipson, he recommends that companies and countries (even beyond the United States and China) should be aware of the impact of the growing number of "import-reducing" policies enacted worldwide. Toward that end, Evenett has been part of a team that has spent the past 18 months developing a database of all the measures governments around the world have put in place that affect global commerce.
The results so far should give lawmakers pause. Global Trade Alert researchers have analyzed 22 protectionist measures that harm 15 or more G20 trading partners and affect more than $10 billion in trade. They estimate that the trade covered by these "jumbo" measures alone is around $1.6 trillion.
Despite the surfeit of government actions, and the resulting ripple effects that have harmed trade, Evenett doesn't think companies need to be worried about a major trade war erupting. But he is concerned about the escalating trade tensions between the United States and China. "What we see bubbling up is quite worrisome," he concedes. "It's setting the scene for a very frightening 2011."
Janet Kersnar is a London-based journalist.
Land of the Sinking Yen
By intervening to stop a strengthening yen, Japan's central bank throws uncertainty into the forex strategies of U.S. companies.
Japan's recent moves to weaken the yen have created another headache for U.S. finance chiefs. While big Japanese exporters such as Sony and Honda cheered their central bank's efforts to halt the yen's five-month climb against the dollar, the intervention presents quite a different set of issues for American companies.
The yen moved from 83.72 yen to the dollar to 85.74 yen to the dollar in mid-September, before snapping back to 82.38 in early October. According to an executive at Nissan Motor, many companies in Japan are not profitable even at the rate of 90 yen to the dollar, and a continued strong yen could mean domestic job losses.
U.S. automakers, of course, welcome a strong yen because it makes Japanese cars less price-competitive in the United States. But it also means higher costs for U.S. manufacturers importing large machinery or parts from Japan.
Ryan Gibbons, managing director of GPS Capital Markets, says the Japanese central bank's move to flood the markets with yen is a wake-up call to U.S. CFOs who have been riding the profits from the currency's appreciation the past few months. "Take a more conservative approach now," counsels Gibbons. "If you're in the money on hedges, you should lock into those."
A still-ailing U.S. economy won't assist Japan's devaluation strategy. Continuing low interest rates in the United States have helped strengthen the yen as investors move money out of dollars. Quantitative easing by the Federal Reserve could cause further dollar depreciation and counteract the intervention.
Still, the yen is more likely to weaken than return to preintervention levels, Gibbons says. CFOs have some time to let the situation play out before final budgets for 2011 are due, but for those starting the process now, Gibbons recommends being at least 5% more conservative with yen-dollar exchange-rate projections. Meanwhile, another round of intervention appeared possible at press time. — Vincent Ryan