China’s Exporters Hanging by a Thread?

Has the Chinese export sector become hostage to WalMartization, the ability of powerful retailers to squeeze vendor profit margins?

Reader Michael Q called our attention to a key remark in a Wall Street Journal story:

Vice Commerce Minister Zhong Shan, in an exclusive interview Thursday ahead of a visit to the U.S., said that the profit margin on many Chinese export goods was less than 2%.

Most exporters absorbed the appreciation in the value of the yuan that followed its revaluation in 2005 by boosting innovation and cutting costs, but many were forced to close, he said. A further rise in the currency’s value would endanger more exporters’ survival, which China can’t afford, he said.

As Michael Q, who is an equity analyst, noted:

2% margins on export-oriented businesses is not representative of any sort of real competitive advantage. A real competitive advantage when it comes to exporting would show double-digits profit margins. This whole sector is hanging by a thread…nearly none of the activity China has engaged in since the downturn is secular or self-sustaining.

Yves here. The implications for China are serious. First, this says that it perceives it has no room to revalue the RMB upwards. Not only are exporters politically powerful, but on a more mundane level, the regime has achieved social cohesion through a promise of rising prosperity. Too much unemployment would undermine the legitimacy of the governing classes.

But second, it also implies China cannot even tolerate much inflation. Remember, inflation will push up the price of good in local currency terms, which in a fixed peg currency regime, translates directly into price increases. Price increases from a country whose selling proposition is cheap prices would lead importers to look for substitutes in other emerging economies. A 2% margin not only says manufacturers have no room to cut prices, it also says they cannot afford much in the way of lost revenue.

This dynamic makes the idea floated on the blog earlier, that China might devalue the RMB, less radical than it might seem.

Originally published at Naked Capitalism and reproduced here with the author’s permission.