It's not just about the yuan

Yuan: Who will be a bigger driver of global trade rebalancing — the People’s Bank of China or the country’s migrant workers? The PBoC guides the yuan exchange rate, which US politicians and investors are fixated on. But other factors, including labour costs, are probably doing more to increase the cost of exports from China.

China’s yuan reforms got off to a slow start on Monday. The central bank set the daily mid-point for yuan trading at Friday’s level. The currency strengthened slightly thereafter, rising by about a third of a per cent in the afternoon to its strongest level since late 2008.

But the dollar exchange rate is only one number — and maybe not the right one to watch. The People’s Bank of China watches closely the so-called “effective exchange rate”, tracked by the Bank for International Settlements. That is measures of relative costs among different countries.

This rate rose 4.8 per cent from November 2009 to this May, and 3.4 per cent in May alone, according to the BIS. By that measure, Chinese competitiveness is at its worst level since 1994, except for the eight crisis-wracked months after October 2008.

Labour and energy costs are making Chinese goods more expensive. Fourteen provinces have already raised their minimum wages by 20 per cent this year, not to mention high-profile pay hikes at companies such as Foxconn and Honda. Chinese gasoline prices, meanwhile, are now 60 per cent higher than in the United States, having been roughly equal in 2008.

Higher costs are already making Chinese goods less attractive to both foreign and domestic buyers. China posted its first monthly trade deficit in six years in April and only narrowly returned to trade surplus in May. The euro crisis only partly explains the shift. The nominal yuan exchange rate will continue to be a focus for China's trade partners. It has risen 20 per cent against the dollar since 2005, and may have further to go. Yet labour costs have doubled during the same period, taking official data on rural income levels as a guide. That should be a much powerful force for shrinking China’s trade surplus.