China's Currency Adjustments are Just the First Step on a Long Rebalancing Path
This article on McKinsey Quarterly (free registration required to view the enitre article) makes some sound arguments as to why the risk of tumult during the upcoming global rebalancing process is high, and what companies can and should do to prepare. The author feels that severe currency adjustments are possible, maybe even likely, as China begins to give some grounds on its peg to the dollar, for two reasons:
- Unemployment may be more structural than cyclical now - this may force governements to allow their currency to weaken further (intentonally or accidentally) to provide advantages to exporters and try to drive employment growth
- Existing exchange rates are suppressing the appropriate signals and incentives in commodity markets - at today's rates, commodities are underpriced in developed economies and overpriced in developing ones, thus encouraging overuse in the former and insufficient use in the latter. Natural tendencies will be for this to reverse, especially as domestic demand grows in developing economies.
The recommendations for company executives are as follows:
- Don't assume today's global realities (specifically, low cost labor in developing economies) will continue, and begin looking at alternate scenarios and developing responses in advance.
- Err on the side of being prepared for these risks to occur - be overliquid and overcapitalized
- Do scenario planning around unthinkables - such as $300 oil, a 30% shift in exchange rates in a rapid period, etc. Since the last financial crisis was (at least) partly driven by commodity price surges, such scenarios are no longer unrealistic.
- Stop thinking that "some day" developing economies will have sufficient local demand, and start acting as if they already do - treat China as your "second home"
