updated 1/15/2007 12:44:31 PM ET 2007-01-15T17:44:31

Dependent on exports to the United States, the Hebei Lihua Hat Co. saw its profits wiped out as China's currency rose steadily against the dollar over the past year.

Hebei Lihua, which sold 90 percent of its 4 million hats to overseas markets last year, fought back by pushing its 1,800 workers to cut waste and find cheaper raw materials. It tried to boost revenues by introducing a new waterproof hat.

Yet even those efforts might be inadequate, said Wang Zhenhao, the business manager for Hebei Lihua, located in Baoding, a city southwest of Beijing.

"If the appreciation continues, we will probably lose money," Wang said.

Chinese companies that supply U.S. retailers with billions of dollars worth of toys, furniture and other goods every year face a painful squeeze as the yuan rises, setting off a race to cut costs or find new products that Americans will pay more for.

Beijing has let the yuan creep up by 6 percent against the dollar since July 2005, easing currency controls as part of long-term efforts to defuse strains caused by a multibillion-dollar influx of export revenues and investment. The yuan most recently was trading at about 7.81 to the dollar.

Washington is pressing Beijing to let the yuan, also known as the renminbi, or people's money, rise faster. It says the yuan is undervalued, giving Chinese exporters an unfair price advantage and widening the U.S. trade deficit with China.

The United States says its trade gap with China for the first 11 months of 2006 reached an all-time high of $213.5 billion, surpassing the full-year record of $202 billion set the previous year.

The yuan's rise is small compared with swings in the yen and the euro against the dollar in recent years. But it is jarring for Chinese exporters, whose profit margins are thin and whose only competitive edge is low prices. Unlike Japanese or European companies, they lack technology and brand names that might keep American customers loyal even as prices rise.

"We do not welcome the renminbi revaluation. It will increase China's export cost and diminish our competitive strength," said Zhao Hong, a spokesman for the China Textile Association, an industry group.

Zhao said the group wants members to invest in developing profitable brands by improving quality.

"We expect to produce more new and improved goods in the future, so that can lessen side affects caused by the change," he said.

The pain should be concentrated in export industries, with little impact on U.S. consumers or China's broader economy, because Beijing is restraining the speed of the yuan's rise, said Andy Rothman, chief China strategist for investment bank CLSA Asia-Pacific Markets.

"I don't think the impact on most Chinese companies will be that significant," Rothman said.

Beijing has given no sign it will slow the yuan's rise, despite the possible threat to employment at a time when the government needs to create jobs for a growing work force and millions of people laid off in the overhaul of state industry.

"When they started out on this process, they knew that some people would be hurt," said Rothman. "If they can see the results are necessary to put the economy on a sounder footing long-term, then they can deal with the pain."

A more muscular yuan also helps the large segment of China's export industries that rely on foreign raw materials.

Many manufacturers assemble imported components, supplying little more than labor and adding just 20 percent to 30 percent of the value of air conditioners, sports equipment and other goods, experts say.

And some Chinese industries are enjoying a windfall.

Oil refiners are racking up fat profits on lower costs for imported crude. Airlines are seeing the cost of Boeing Co. and Airbus Industrie jetliners fall. Banks are richer as the value of their Chinese assets climbs in dollar terms. Companies that invest abroad are paying less for stocks and other assets.

But costs are rising for those that use Chinese materials.

The Anji Henglin Furniture Co. is paying more for wood, plastic and other materials, said Mei Yimin, the director of its foreign trade department. The company, in the southeastern province of Zhejiang, says it was China's 11th-biggest furniture exporter last year with sales of $26 million.

"It is even worse that the appreciation is taking place bit by bit, which makes it more difficult to negotiate with distributors," Mei said. "If it happened by a big margin overnight, they would have no option but to share the loss."

Galanz Group Co., which exported $700 million worth of microwave ovens and other appliances last year, renegotiated contracts with U.S. retailers, which agreed to share exchange rate losses, said Liu Guizhong, deputy general manager of Galanz's foreign trade unit.

"If they didn't agree, we would have shortened the contract from one year to half a year or three months to avoid the risk," Liu said.

Loosening currency rules
Beijing embarked on exchange-rate reform as part of a long-term effort to make its financial system more flexible. The government says it will eventually let the yuan trade freely on world markets and will end barriers to the movement of money in and out of the country.

The surge in export revenues has strained China's ability to contain inflation without letting the yuan rise. The central bank drains billions of dollars a month from the economy by selling bonds and has piled up reserves estimated to exceed $1 trillion.

A top Chinese economic official, Vice Premier Wu Yi, told visiting U.S. Treasury Secretary Henry Paulson in December that Beijing would continue exchange rate reforms but at its own pace.

Beijing is trying to reduce its dependence on low-profit exports by encouraging China's own consumers to spend more and prodding companies to invest in creating new technologies and brand names.

VTech Holdings Ltd., a Hong Kong company, has a work force of 20,000 in China making educational toys for sale in the United States.

It responded to the yuan's rise by boosting spending to develop new toys, said a manager in its finance department who would give only his surname, Yao.

"We are trying to lead the market," Yao said, "so that we can sell at higher prices."

Copyright 2007 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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