China's decision to revalue its currency may play well in Washington, but it could raise hackles among Silicon Valley executives and their customers.
The government of China said Thursday that it will base the exchange rates for its yuan on a "basket" of different currencies rather than maintaining a strict ratio with the U.S. dollar, a decision that's expected to cause the yuan's value to rise. Though they did not say which currencies are in that basket, the move resulted in an immediate 2 percent appreciation of the yuan to 8.11 per dollar.
The country had long been criticized for policies that kept the value of China's currency low and exports to the United States and Europe high.
Few expect the U.S. and European trade deficits with China to change appreciably because of the revaluation, but the surprise currency-strengthening move could be a double-edged sword for the high-tech industry.
On one hand, it's likely to mute calls in Washington for punitive tariffs on Chinese goods, said John Norris, chief economist and senior fund manager at Morgan Asset Management. That would have unquestionably raised consumer prices and dinged corporate earnings.
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China plans to base the exchange rates for its yuan on a "basket" of different currencies rather than maintaining a strict ratio with the U.S. dollar.
If the yuan continues to strengthen, the cost of manufacturing products such as semiconductors, computers and consumer electronics in China will rise, leading to higher prices for consumers and smaller profits for computer companies.
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Why corporate earnings? During the past 11 years, Chinese exports have increased 6.5 times, Morgan Stanley chief economist Stephen Roach recently wrote in a report. But 62 percent of that growth has been driven by the subsidiaries of non-Chinese companies, include some from the United States.
"If this gets some people in Washington to cool off, then it's a good thing," Norris said.
But if the yuan continues to strengthen beyond what is arguably a token measure, the cost of manufacturing products such as semiconductors, computers and consumer electronics in China will rise, leading to--once again--higher prices for consumers and smaller profits for computer companies.
"If finished products become more expensive and sales decline, then what have you gained?" said John Greenagel, a spokesman for the Semiconductor Industry Association, a U.S. trade group. "There is no such thing as an unmixed blessing. We did not take a stand urging China to do this, and as a result we'll be watching cautiously to watch the impact."
The key for trade officials on both sides of the Pacific will be to maintain that tricky equilibrium between placating protectionists and managing manufacturing costs.
For now, Chinese officials said they will not allow the yuan to rise or fall more 0.3 percent against the dollar, once a benchmark is established. Chinese officials also kept their plans vague and gave themselves plenty of leeway to manage rates, making drastic changes unlikely.
A silver lining
There's also a significant upside to this: A stronger yuan could mean China's increasingly affluent middle class will be able to afford more products and services from American tech companies.
Clearly, America's tech giants are homing in on Chinese consumers. Earlier this week, Microsoft sued Google for hiring the main architect of the software giant's Chinese business strategy. Also this week, the analyst firm Gartner predicted that the sale of cellular phones will reach 1 billion units annually by the end of the decade, largely fueled by demand in Asia.
Additionally, Chinese businesses may absorb the cost of a new exchange rate rather than pass them onto customers and jeopardize demand, said Robert Brusca, chief economist at FAO Economics.
"It's not a question or a matter of currency. Their advantage is far, far greater than that," Brusca said. "They pay so little for their workers--two to three times less or even less than what we pay in the U.S. So even if the exchange rate moves 10 or 15 percent, it won't be something that will undermine the cost advantage that China currently has."
Computer companies should also have plans to identify alternative suppliers if the yuan really does spiral upward, said David I. Levine, an economics professor at the Haas School of Business at the University of California, Berkeley. "Those contingencies should be part of every high-tech company's plans," Levine said. "This relatively minor currency revaluation shouldn?t be putting those contingency plans in motion."
Still, industry watchers are finding reasons to fret about the Middle Kingdom. They fear China could drive up energy prices by using its stronger currency to outbid other nations for limited oil supplies. That, in turn, could dampen the global economy and consumer spending, the SIA's Greenagel said.
"It may not be as simple as some people think, that it's just going to make (U.S.) exports to China less expensive," Greenagel said. "There are other implications. We're just staying cautious."
CNET News.com's Jim Kerstetter contributed to this report.