China's Labor Arbitrage May Now Be Turning With a Vengeance

The Mexican peso is getting crushed by the Chinese renminbi

Suntron de Mexico Assembly Plant

A woman works on an electronics component assembly line at the Suntron de Mexico assembly plant.

Photographer: David Maung

For US manufacturers exploring production facilities outside the country, the comparison to the MXN (at a record low versus the USD this month) to the CNY is particularly important. Not only has the MXN depreciated about 50% cumulative versus the CNY over the last decade, but it is actually easier to move goods from Mexico than China to US plants/consumers. On Bloomberg TV this morning, co-host Brendan Greeley indicated that more auto parts are produced in Mexico than in the US, a comparison that is unlikely to change with the USD up about 20% versus the MXN over the last year. While auto parts has traditionally been a strong export from Mexico to the USD (large, heavy items that are more cheaply shipped from Mexico than China), there is increasing potential that additional production activity could be relocated from more expensive Chinese producers to more competitive ones in Mexico, and also to S. Korea, Brazil, India and, if the weakness in the CAD persists, Canada. —Robert Sinche, Amherst Pierpont Securities.

It is a one-way train, and the train is laden with automobiles and auto-parts and who knows what else, and it's going from Monterrey to Indianapolis ASAP.

That is just one example of the many logistic threads being spun as foreign exchange adjustment crushes China and advances Mexico.

Foreign direct investment (FDI) into Mexico creates jobs that make stuff that migrates north. And it starts with a massive appreciation of the China renminbi and a depreciation of the Mexico peso. FX matters, and for Robert Sinche, of Amherst Pierpont Securities, MXN-CNY is win-win for Mexico and U.S. consumers.

MXN-CNY: The number of yuan per peso. South is a weaker peso and a stronger renminbi.
MXN-CNY: The number of yuan per peso. South is a weaker peso and a stronger renminbi.

Here is Sinche's chart that combines two trends pros have tattooed to their brains: a) The yuan, or renminbi, has appreciated dramatically when compared with the U.S. dollar; and b) the same dollar has appreciated dramatically when compared with the peso. That means massive appreciation of the yuan compared to the peso, a more obscure currency pair or cross-rate and one measure of relative labor cost. To show how poorly the peso has done, we show the abrupt depreciation in 2008 and the minor recovery, then a rollover to further persistent peso erosion. Steve Roach, ex-Morgan Stanley economist, has written for decades of the "labor arbitrage" that China enjoyed.

That may now be turning with a vengeance.

In 2005, the Chinese "floated" the renminbi and managed its appreciation. The currency has appreciated about 25 percent against the dollar. The dollar has appreciated roughly 33 percent vs. the peso. And MXN-CNY is showing about a 50 percent appreciation for the yuan. Perhaps what is most distressing for Beijing is the inertial force of the trend. As Sinche suggests, "the Chinese economy has slowed, in part, due to the stagnation of export growth over the last year."


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