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What's Yuan Gotta Do With It?

giggsy said...
Quoted "Yuan will be allowed to appreciate more for the rest of the year. What a good investment option ... mind if I ask, what made you said that for the above statement? thanks, Jeff
p/s since you used the nick of probably M.U.'s all time best player next to Cantona, gotta try and answer your question ...

China's yuan has been pegged to a flat dollar within a narrow band (0.3%) around an official rate of 8.28 to 1 since 1995. Even though the yuan is still not entirely freely convertible, China has made deliberate moves to allow the yuan to appreciate in light of its enormous trade surpluses. Now the rate is 7.72, and more significantly even surpassed the HK dollar's 7.81 rate! The US is about the only country that can have a seemingly strong currency that leads to trade deficits is in its national interest in a global economy dominated by international trade. This is because a strong dollar backed by high interest rates helps produce a US capital account surplus to finance its trade deficit. The strong dollar scenario has been mentioned many times in this blog - it has to do with the rest of the world wanting to keep holding dollars: indirectly as a result of US's global military leadership (like it or not). However, even US lawmakers are now willing the dollar to go weaker as they know continuing trade deficits financed by an artificially held capital account is unsustainable. To keep paying down US debts by printing more US dollars, the rest of the world has to be willing to keep taking it up the ass. Maybe the rest of the world is feeling a tad uncomfortable in their nether regions; maybe more central banks are diversifying their currency reserves portfolio more; maybe more oil and gas won't be transacted in USD; etc... Its not the end of the dollar but things are starting to unwind.

Its What US Wants - Treasury secretary Henry Paulson told the Senate that the US should encourage China "fairly aggressively" to allow its currency to respond to market forces and appreciate against the dollar. US lawmakers think a stronger yuan is the main cure for their economic ills, in particular the unmanageable trade deficit. Of course, in my opinion, I think the yuan is the least of their problems.

A Reflection Of Competitiveness - The best reflection is in the trade surplus as more willing buyers, and the country can produce at attractive prices. It is unlikely we will see China registering a trade deficit, not for at least 5-10 years down the road.

Trade Surplus A Reflection Of Consumption - While China may have more than a billion people, not all are caught up in the economic growth cycle. This will reduce the consumption growth patterns, i.e. imports. However, to use the currency as the rebalancing lever in trade deficits and surpluses is myopic as it does not take into account the very different monetary system within China, plus the currency is only semi-convertible.

Relative Interest Rates & Growth Rates - China is entering its 10th year of growth. Its bank lending rate is a tad over 6% while Fed funds is closing in at 5% soon and lower in the medium term. All things being equal, funds flow to higher interest rates and growth rates.

Productivity Faster Than Currency Growth - If yuan is allowed to appreciate a few percent every year, wouldn't that hurt competitiveness. Usually yes, but in China the growth in productivity and cost savings outstrips the mild increments in the yuan. As long as productivity maintains the same higher path than the yuan's growth rates, yuan can appreciate for a very long time. Look at the way commodities and oil prices surged over the last 4 years, mainly due to China being a major consumer of those stuff to produce goods. China can stomach these higher commodity and oil prices because they can add a lot more value and productivity to the processes.

Outsourcing Capital - There is the cheapest price and there is the China price. Usually they are the same thing. The biggest phenom over the last 5 years is the outsourcing trend. Capital and jobs flow to China, and flows back to developed nations in the form of exports. Low labour unit cost and land cost all add up to China's benefit. Companies will outsource whatever they can in order to grow margins and remain competitive. Its the big paradigm shift.

China Has To Do It - China has to allow the yuan to appreciate to appease a whole truckload of people, from US lawmakers, to WTO, to United Nations, to regional trade groupings calling for a better and more level playing field ... The political overtones are not to be under-estimated.

The general feeling is that the central bank will allow for a 3%-4% appreciation in 2007 and another 5%-6% in 2008. Although I would not be surprised if the band was widened on the high side. A stronger trending yuan is very good news for its smaller Asian neighbours. Everyone is looking at relative competitiveness. A stronger trending yuan gives export driven nations such as Thailand, Malaysia and India more room to manouvere.

Other inherent traits for a strong currency such as high savings rate and strong FDIs are all there, what more do you want. However, it is also the very strong belief for a long term strong trending yuan that has led to a surge in liquidity into yuan assets. The biggest beneficiaries are stocks and real estate. A strong currency outlook attracts a lot of hot money. Hot money will circulate for good returns. Central bank frowns on hot money in the system. So, its the usual tug of war for China's central bank - good problems to have.
For those who are curious why I always whack the Anchor & Adjust decision makers, have a look at where the yuan peg was before. In 1986 the yuan forex swap rate was at 5.2 yuan to the dollar! In 1991 the forex swap rate was 5.9 yuan to the dollar. In 1993 the forex swap rate went to 8.7 yuan to the dollar!!! So after some 20-25 years, we are seeing a reversing of a trend, and in this case the trend can be a bloody long term thing.

Comments

sopskysalat said…
Other inherent traits for a strong currency such as high savings rate and strong FDIs are all there, what more do you want. However, it is also the very strong belief for a long term strong trending yuan that has led to a surge in liquidity into yuan assets. The biggest beneficiaries are stocks and real estate. A strong currency outlook attracts a lot of hot money. Hot money will circulate for good returns. Central bank frowns on hot money in the system. So, its the usual tug of war for China's central bank - good problems to have.

Ahhaa... Dali, hot monies into stocks and real estate. In view of the tightening and slew of measures to slow down these hot monies, are we not really seeing a tug of war? It's hard now.

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