Chinese Yuan: Further Appreciation is Inevitable

Relatively speaking, the Chinese Yuan has been on a tear, appreciating ~1% in a little more than a month. One has to wonder whether this is a concession by the People’s Bank of China (PBOC) that its exchange rate regime is not viable or whether its instead a political sop. The question on everyone’s minds, of course, <br /><a name="more"></a>is, <em>will it continue? </em><br /> <a href="http://www.forexblog.org/wp-content/uploads/2011/02/CNY-USD-3-month-chart.png"><img alt="" class="aligncenter size-full wp-image-3715" height="288" src="http://www.forexblog.org/wp-content/uploads/2011/02/CNY-USD-3-month-chart.png" title="CNY USD 3 month chart" width="512" /></a><br />Countries around the world have continued to criticize China for its unwillingness to allow the Yuan to appreciate. At last week’s G20 meeting, US Treasury Secretary Timothy Geithner and Fed Chairman Ben Bernanke separately took aim. “They’re still <a href="http://www.bloomberg.com/news/2011-02-19/china-still-resisting-yuan-appreciation-geithner-tells-bbc.html">heavily leaning against</a> the forces trying to push their currency up,” complained Geithner. “The maintenance of undervalued currencies by some countries has contributed to a pattern of global spending that is <a href="http://www.bloomberg.com/news/2011-02-18/bernanke-criticizes-china-s-policy-of-keeping-yuan-low-amid-trade-surplus.html">unbalanced and unsustainable</a>,” intimated Bernanke.<br /> However, it was only when fellow emerging market economies – namely Brazil – voiced similar concerns, that China was finally forced to concede partial defeat. It signed on to an <a href="http://www.marketwatch.com/story/china-yuan-reform-to-move-gradually-pboc-chief-2011-02-21?reflink=MW_news_stmp">official G20 communique</a> that declared that exchange rates and current account balances would be used to determine whether a particular country’s policies were contributing to global economic imbalances. Alas, the Communique (and the G20, for that matter) is deliberately vague and unenforceable; it’s more symbolic than anything else.<br /> Still, China is not one to take its cues – especially on issues as important as the Yuan – from the international community. That the Yuan is now appreciating at a steady clip (~5% in annualized terms) is almost certainly being <a href="http://www.forexblog.org/2011/01/chinese-yuan-continues-to-tick-up.html">driven more by pragmatism than politics</a>. Specifically, it represents the most effective tool to combat inflation, which has already breached 5% and continues to tick higher.<br /> <a href="http://www.forexblog.org/wp-content/uploads/2011/02/China-Inflation-Rate-2000-2011.jpg"><img alt="" class="aligncenter size-full wp-image-3716" height="297" src="http://www.forexblog.org/wp-content/uploads/2011/02/China-Inflation-Rate-2000-2011.jpg" title="China Inflation Rate 2000 - 2011" width="632" /></a><br /> China critics forget that China’s fixed exchange rate regime is not a free lunch. While it almost certainly gives the export sector a competitive advantage, it also deprives the PBOC of the ability to conduct monetary policy and is inherently inflationary. That’s because the policy necessitates soaking up all of the foreign currency that enters the country (hence the <a href="http://www.forexblog.org/2010/10/china-diversifies-forex-reserves.html">~$3 Trillion in forex reserves</a>) and instead printing new Chinese Yuan and putting into circulation. When you combine a 15% annual increase in the money supply with soaring economic growth, a surge in bank lending, real estate boom, and rising commodity prices, the inevitable result is inflation. The country’s economic officials have responded by <a href="http://www.businessweek.com/news/2011-02-08/china-raises-rates-to-counter-accelerating-inflation.html">tightening credit and raising interest rates</a>, but these will ultimately fail as long as the Fed’s QE2 program continues to send US Dollars into China.<br /> In addition to allowing the Yuan to slowly appreciate, China has also moved to <a href="http://www.marketwatch.com/story/china-adds-to-steps-to-internationalize-yuan-2011-02-16?pagenumber=2">make the Yuan more convertible</a>. This has the dual advantages of making China less reliant on the US Dollar and on relieving upward pressure on the Yuan. More of its trade is being settled directly in Chinese Yuan. Chinese companies are being encouraged to invest outside of China, and foreign companies inside of China are gradually being permitted to issue Yuan-denominated bonds, rather than import Dollars to fund new investments.<br /> It appears that all of these measures are actually starting to have some impact. China’s <a href="http://www.nytimes.com/2011/02/15/business/global/15yuan.html?_r=1">trade surplus is shrinking.</a> The IMF <a href="http://www.rttnews.com/Content/AsianEconomicNews.aspx?Id=1557338&SM=1">has suggested</a> that the Chinese Yuan could one day be an international reserve currency and could be a component of its Special Drawing Rights (SDR) currency. Less hot money (distinct from investment inflows) is finding its way into China.<br /> Unfortunately, most analysts are skeptical that it will last. Futures markets reflect a modest 2.5% appreciation against the Dollar over the next 12 months. I’m personally anticipating a rise of 4-5%, though I think it will ultimately be tweaked depending on inflation.<br /> <div style="text-align: center;"><a href="http://www.forexblog.org/wp-content/uploads/2011/02/USD-CNY-March-2012-Futures.jpg"><img alt="" class="aligncenter size-full wp-image-3717" height="259" src="http://www.forexblog.org/wp-content/uploads/2011/02/USD-CNY-March-2012-Futures.jpg" title="USD CNY March 2012 Futures" width="528" /></a></div>

Chinese Yuan: Further Appreciation is Inevitable

Relatively speaking, the Chinese Yuan has been on a tear, appreciating ~1% in a little more than a month. One has to wonder whether this ...

Read more »

Is the Chinese Yuan the Most Reliable Forex Trade?

Over the last six years, the appreciation of the Chinese Yuan has been as reliable as a clock. Since 2005, when China tweaked the Yuan-Dollar peg, it has risen by 28%, which works out to 4.5% per year. If you subtract out the two year period from 2008-2010 during which the Yuan was frozen in place, the appreciation has been closer to 7% per year. There is no other currency that I know of whose performance has been so consistently solid, and best of all, risk-free!<br /><a name="more"></a><br /> <div style="text-align: center;"><a href="http://www.forexblog.org/wp-content/uploads/2011/06/CNY-USD-2004-2011.jpg"><img alt="" class="aligncenter size-full wp-image-4126" height="216" src="http://www.forexblog.org/wp-content/uploads/2011/06/CNY-USD-2004-2011.jpg" title="CNY USD 2004 - 2011" width="553" /></a></div>As I wrote in an <a href="http://www.forexblog.org/2011/05/the-diminished-case-for-chinese-yuan-appreciation.html">earlier post</a> on the subject, the economic case for further appreciation is actually somewhat flimsy. When you factor in the 5-10% inflation that has eroded the value of the Yuan over the last few years, its appreciation in real terms has more than exceeded the 25-40% that economists and politicians asserted as the margin by which it was undervalued. While prices for many services remain well below western levels, prices for manufactured goods already equal or exceed those that Americans pay. (As a resident of China, I can assure you that this is the case!). Given that Chinese GDP per capita (a proxy for income) is 12 times less than in the US, that means that relative price levels in China are already significantly greater than the US. Thus, further appreciation would only cause further distortion.<br /> Regardless, investors continue to brace for further appreciation, and <a href="http://www.reuters.com/article/2011/04/29/markets-china-yuan-idUSL3E7FT1BS20110429">expectations of 5-6%</a> for the foreseeable future are the norm. Even futures contracts – which typically lag actual appreciation because of their non-deliverable nature – are pricing in higher expectations for appreciation. Perhaps the greatest indication is that <a href="http://online.wsj.com/article/BT-CO-20110415-702240.html">9% of all of the capital pouring into China is so-called “hot-money.”</a> That means that despite the 27% appreciation to date, a substantial portion of investment in China is connected only to the expectation for further Yuan appreciation.<br /> Even though the Yuan is not fully-tradeable, its continued rise has serious implications for forex markets. First of all, there will be follow-on effects for other currencies. Almost every emerging market economy competes directly with China, and all are thus keenly aware that China pegs its currency against the US dollar. By extension, many of these economies feel they have no choice but to intervene daily in forex markets to prevent their respective currencies from appreciating faster than the RMB.<br /> At the very least, the appreciation in Asian and Latin American currencies will keep pace with the Yuan: “This is a long-term secular trend for emerging market currencies especially in Asia. Asian currencies have long been undervalued and they are on a convergence path with the United States and the G7 more broadly and that’s going to lead to an appreciation,” summarized <a href="http://www.reuters.com/article/2011/05/17/us-markets-forex-yuan-idUSTRE74G6ZH20110517">one analyst</a>.<br /> All of this action will cause the dollar to depreciate. The Chinese Yuan alone accounts for 20% of the <a href="http://www.federalreserve.gov/releases/H10/weights/">Federal Reserve Bank’s trade-weighted dollar index</a>, and Asia ex-Japan accounts for another 20%. Regardless of the other G4 currencies perform, that means that a conservative 7% annual appreciation in Asia will drive a minimum 3% annual decline in the trade-weighted value of the dollar. Even worse is that this cause a broad loss of confidence in the dollar, driving the dollar lower across-the board. And this doesn’t even aaccount for the multiplier effect that net exporters will no longer need to indiscriminately accumulate dollar-denominated assets. China, itself, has unloaded part of its massive hoard of US Treasury securities for <a href="http://online.wsj.com/article/SB10001424052748703509104576327011093811614.html">five consecutive months</a>.<br /> <div style="text-align: center;"><a href="http://www.forexblog.org/wp-content/uploads/2011/06/Emerging-Market-Asian-currencies-2011.jpg"><img alt="" class="aligncenter size-full wp-image-4129" height="209" src="http://www.forexblog.org/wp-content/uploads/2011/06/Emerging-Market-Asian-currencies-2011.jpg" title="Emerging Market Asian currencies 2011" width="535" /></a></div>The implications for how long-term investors should position themselves are clear. Unfortunately, while further appreciation in the Chinese Yuan is all but guaranteed, achieving exposure to this appreciation is beyond difficult. Neither of the ETFs that claim to represent the Yuan (CNY, CYB) have budged over the last couple years, and they are a poor substitute for the actual thing. In other words, your only chance for exposure is indirectly via Chinese stocks and bonds, which are far from transparent and an extremely dubious investment. Or you could try opening a Chinese Yuan bank account with the Bank of China (which now has branches in the US), but it’s unclear whether you will be able to capture 100% of gains from the Yuan’s appreciation.<br /> Otherwise, emerging market Asia seems like a pretty good proxy. Of course, you need to be aware that even though the Korean Won, Malaysian Ringgit, Thai Baht, New Taiwan Dollar, Indonesian Rupiah, Philippine Peso, etc. will probably at least match the rise in the Yuan, they are imperfect substitutes for the Yuan, since they are driven more by country-specific factors than by association to China.

Is the Chinese Yuan the Most Reliable Forex Trade?

Over the last six years, the appreciation of the Chinese Yuan has been as reliable as a clock. Since 2005, when China tweaked the Yuan-D...

Read more »

The Diminished Case for Chinese Yuan Appreciation

The Chinese yuan has appreciated by more than 27.5% since 2005, when the People’s Bank of China (“PBOC”) formally acceded to international pressure and began to relax the yuan-dollar peg. For China-watchers and economists, that the Yuan will continue to appreciate is thus a given. There is no question of <em>if</em>, but rather of <em>when</em> and <em>to what extent</em>. But what if the prevailing wisdom is wrong? What if the yuan is now fairly valued, and economic fundamentals no longer necessitate a further rise?<br /><a name="more"></a><br /> <div style="text-align: left;"><img alt="" class="aligncenter" height="340" src="http://www.forexblog.org/wp-content/uploads/2011/05/US-Dollar-Chinese-Yuan-10-year-chart.png" title="US Dollar Chinese Yuan 10-year chart" width="567" /><br />Prior to the 2005 revaluation, economists had argued that the yuan (also known as the Chinese RMB) was <a href="http://www.forexblog.org/2005/06/is-the-yuan-really-undervalued.html">undervalued by 15% – 40%</a>, and American politicians had used this as a basis for proposing a 27.5% across-the-board tariff on all Chinese imports. Given that the yuan has now appreciated by this exact margin (and by even more when inflation is taken into account), shouldn’t this alone be enough to silence the critics, without even having to look at the picture on the ground? How can Senator Charles Schumer <a href="http://online.wsj.com/article/SB10001424052748703856704576285380858477662.html">continue to press for further appreciation</a> when the yuan’s rise exceeds his initial demands? Alas, election season is upon us, and we can’t hope to make political sense out of this issue. We can, however, attempt to analyze the economic sense of it.</div>China manipulates the value of the yuan in order to give a competitive advantage to Chinese exporters, goes the conventional line of thinking. Look no further than the Chinese trade surplus for evidence of this, right? As it turns out, China’s trade surplus is shrinking rapidly. In 2006, it was a whopping 11% of GDP. Last year, it had fallen to 5%, and it is <a href="http://online.wsj.com/article/SB10001424052748704463804576290293851753066.html?mod=googlenews_wsj">projected by the World Bank</a> to settle below 3% for each of the next two years. Thanks to a first quarter trade deficit – the first in over seven years – China’s trade surplus may account for a negligible portion (~.2%) of GDP growth in 2010.<br /> <div style="text-align: left;"><img alt="" class="aligncenter" height="270" src="http://www.forexblog.org/wp-content/uploads/2011/05/China-Balance-of-Trade.png" title="China Balance of Trade" width="630" /><br />With this in mind, why would the PBOC even think about allowing the RMB to appreciate further? According to one perspective, the narrowing trade imbalance is only temporary. When commodities prices settle and global demand fully recovers, a wider trade surplus will follow. In fact, the IMF forecasts China’s current surplus will rise to 8% by 2016. As you can see from the chart below (courtesy of <a href="http://www.economist.com/node/18620934?story_id=18620934"><em>The Economist</em></a>), however, the IMF’s forecasts have proven to be too pessimistic for at least the last three years, and it now has very little credibility. Besides, China’s economy is gradually reorienting itself away from exports and towards domestic spending. As a resident of China, I can certainly attest to this phenomenon, and the last few years has seen an explosion in the number of cars on the road, domestic tourism, and conspicuous consumption.</div><div style="text-align: left;"><img alt="" class="aligncenter" height="299" src="http://www.forexblog.org/wp-content/uploads/2011/05/Chinas-Current-Account-Surplus-Actual-and-Predicted.gif" title="China's Current Account Surplus - Actual and Predicted" width="290" /><br />A better argument for further RMB appreciation comes in the form of inflation. At 5.4%, inflation is officially nearing a 3-year high, and there is evidence that the <a href="http://www.bloomberg.com/news/2011-04-12/former-china-central-bank-adviser-yu-calls-for-stronger-yuan.html">PBOC already recognizes</a> that allowing the RMB to keep rising represents its best tool for containing this problem. It has <a href="http://online.wsj.com/article/BT-CO-20110418-706258.html">already raised</a> banks’ <em>required reserve ratio</em> several times, but there is a limit to what this can accomplish. Meanwhile, the PBOC remains reluctant to raise interest rates because it will invite further <a href="http://online.wsj.com/article/BT-CO-20110330-706084.html">“hot-money” inflows</a> (estimated at more than $100 Billion per year, if not much higher) and potentially <a href="http://www.bloomberg.com/news/2011-04-13/china-banks-said-to-need-131-billion-of-equity-over-six-years.html">destabilize the banking sector</a>. By raising the value of the yuan, the PBOC can blunt the impact of <a href="http://online.wsj.com/article/SB10001424052748704366104576254310964824864.html">rising commodities prices</a> and other inflationary forces.</div>In fact, some think that the PBOC will quicken the pace of appreciation, a view that as supported by last month’s .9% rise. Others think that a once-off appreciation would be more effective, and is hence more likely. This would not only remove the motivation for further hot-money inflows, but would also reduce the PBOC’s need to continue accumulating foreign exchange reserves. At $3 trillion+ ($1.15 trillion of which are held in US Treasury Securities), these reserves are already a massive headache for policymakers. Merely stating the obvious, PBOC Governor Zhou Xiaochuan has officially called the reserves “<a href="http://www.marketwatch.com/story/chinas-forex-cache-too-much-of-a-good-thing-2011-05-02?reflink=MW_news_stmp">really too much</a>.” (It’s worth pointing out that the promotion of the yuan as an international currency is <a href="http://online.wsj.com/article/SB10001424052748704821704576270682839679232.html">backfiring in some ways</a>, causing the reserves to balloon even faster).<br /> <div style="text-align: left;"><img alt="" class="aligncenter" height="426" src="http://www.forexblog.org/wp-content/uploads/2011/05/Chinese-Yuan-denominated-trade.png" title="Chinese Yuan-denominated trade" width="233" /> For the record, I think that the Chinese yuan is pretty close to being fairly valued. That might seem like a ridiculous claim to make when Chinese wages and prices are still well below the global average. Consider, however, that the same is true for the majority of emerging market economies, including those that don’t peg their currencies to the dollar. That doesn’t mean that the yuan won’t – or that it shouldn’t – continue to rise. In fact, the PBOC needs to do more to ensure that the Yuan appreciates evenly against all currencies, since most of the yuan’s rise to-date has taken place relative to the US Dollar. It’s merely a commentary that the PBOC is close to fulfilling the promises it has made regarding the yuan, and going forward, I think that observers should expect that its forex policy will be reconfigured to promote domestic macroeconomic policy objectives.</div>

The Diminished Case for Chinese Yuan Appreciation

The Chinese yuan has appreciated by more than 27.5% since 2005, when the People’s Bank of China (“PBOC”) formally acceded to internationa...

Read more »

Report Portends Changes to Forex Reserve Currencies

This week’s Bank of International Settlements (BIS) quarterly report came with some interesting revelations (most of which I’ll discuss in a later post). Below, I’d like to focus on one particularly interesting section entitled, “<a href="http://www.bis.org/publ/qtrpdf/r_qt1103h.pdf">Foreign exchange trading in emerging currencies</a>.” This section carries tremendous implications for the future of reserve currencies and is a must read for fundamental analysts.<br /><a name="more"></a><br /> According to the BIS, “Foreign exchange turnover evolves in a predictable fashion with increasing income. As income per capita rises, currency trading cuts loose from underlying current account transactions…moreover, currencies with either high or very low yields attract more trading, consistent with their role as target and funding currencies in carry trades.” In other words, the most liquid currencies (and hence, most suitable reserve currencies) are primarily those of advanced economies and secondarily those with abnormal interest rates.<br /> In theory, one would expect a close correlation between forex turnover and trade. In fact, this turns out to be precisely the case for lesser-developed countries. Since the capital markets of such countries are commensurately undeveloped, offering limited opportunities for foreign investment, most of the demand for their currencies stems directly from trade. In fact, the currencies of Malaysia, Indonesia, Saudi Arabia, and (notably) China closely fit this profile, with a 1:1 ratio between forex turnover and trade.<br /> <div style="text-align: left;">At the same time, the BIS discovered a strong correlation between the ratio of foreign exchange turnover to trade and GDP per capita.  That means that as a country grows economically and enters the realm of industrialized countries, its currency will experience exponential growth in turnover. For example, the British Pound and Japanese Yen are exchanged at a quantity that is 50 times greater than required for trading purposes. The ratio of forex turnover to trade for the US Dollar, meanwhile, exceeds 100!</div><div style="text-align: left;"><a href="http://www.forexblog.org/wp-content/uploads/2011/04/Ratio-of-Forex-Currency-Turnover-to-trade-in-relation-to-GDP-per-capita.jpg"><img alt="" class="aligncenter size-full wp-image-3833" height="245" src="http://www.forexblog.org/wp-content/uploads/2011/04/Ratio-of-Forex-Currency-Turnover-to-trade-in-relation-to-GDP-per-capita.jpg" title="Ratio of Forex Currency Turnover to trade in relation to GDP per capita" width="500" /></a></div>The BIS was able to fit a regression line to the data that seemed to explain this phenomenon quite well. The majority of economies/currencies that it surveyed fall pretty close to this line, suggesting that forex turnover is exactly where it should be relative to GDP per capita and trade. In fact, the line runs directly through the Euro, Hong Kong Dollar, Canadian Dollar, and Swedish Krona, and Norwegian Krona.<br /> There are also plenty of outliers. Given the size of China’s economy, for instance, the model would predict that turnover in the Chinese  Yuan should be 2-3 times what it currently is. Unsurprisingly, all of the world’s major reserve currencies (except for the Euro) can be found well on the other side of the regression line. Turnover in the US Dollar, Japanese Yen, and Australian Dollar is almost twice as high as the model predicts. Perhaps the most flagrant outlier is the New Zealand Dollar, which seems to be traded at a frequency that is 8-10x higher than it should be. Of course, New Zealand is a unique case; there isn’t another economy that is as small and stable, and yet always has higher-than-average interest rates.<br /> One interpretation of this analysis is that demand for the all of the currencies that fall above the regression line should decline over time, and should experience at least some depreciation. The opposite can be said for currencies that currently fall the regression line, especially if their economies continue to expand at a faster-than average pace.<br /> At the same time, it puts things into perspective. Even if demand for the Chinese Yuan doubled in accordance with the BIS model (which would necessitate looser capital controls, <a href="http://www.forexblog.org/2010/11/chinese-yuan-will-not-be-reserve-currency.html">among other things</a>), GDP per capital would need to increase 20x and US GDP per capita would need to remain constant in order for the Yuan to rival the Dollar in importance. Also, I’m beginning to wonder if the New Zealand Dollar isn’t in fact oversubscribed and overvalued…

Report Portends Changes to Forex Reserve Currencies

This week’s Bank of International Settlements (BIS) quarterly report came with some interesting revelations (most of which I’ll discuss i...

Read more »

G20 Pressures China, Despite Yuan Appreciation

Since the People’s Bank of China (PBOC) unfixed the Chinese Yuan in June, it has appreciated 4.5%. Moreover, for a handful of reasons, it looks like China will continue allowing the RMB to appreciate at the same steady pace for the foreseeable future. And yet, the international community continue to use China as a scapegoat for all global economic ills, and are pressuring it to stop trying to control the Yuan altogether.<br /><a name="more"></a><br /> <a href="http://www.forexblog.org/wp-content/uploads/2011/04/USD-CNY-1-Year-Chart.png"><img alt="" class="aligncenter size-full wp-image-3823" height="288" src="http://www.forexblog.org/wp-content/uploads/2011/04/USD-CNY-1-Year-Chart.png" title="USD CNY 1 Year Chart" width="512" /></a><br />At the recent G20 conference in China, US Treasury Secretary Tim Geithner circumvented China’s request to avoid discussing its currency policy: “<a href="http://online.wsj.com/article/SB10001424052748703712504576233931135818222.html">Flexible exchange rates</a> help countries better absorb shocks and that the tension between flexible currencies and those that are ‘tightly managed’ is ‘the most important problem to solve in the international monetary system today.’ ” Naturally, Chinese officials countered that the Dollar is to blame for the recent financial crisis and the ongoing economic imbalances.<br /> If China was the only country to attempt to control its currency, perhaps the rest of the world would be willing to overlook it and write it off to ideological differences like they do with many of its protectionist economic policies. In this case, however, China’s tight control of the Yuan has spurred many of the countries with which it competes to similarly intervene in forex markets. In the last week alone, South Korea, Malaysia, Singapore, and Thailand are all suspected of buying Dollars to hold down their respective currencies. Meanwhile, <a href="http://www.forexblog.org/2011/03/brazil-gets-real-about-intervention.html">Brazil</a> is enhancing its capital controls and <a href="http://www.forexblog.org/2011/03/wild-ride-for-the-yen.html">Japan stands ready to intervene</a> should the Yen spike again.<br /><a href="http://www.forexblog.org/wp-content/uploads/2011/04/Asian-currencies-vs-Dollar-2010-2011.jpg"><img alt="" class="aligncenter size-full wp-image-3824" height="302" src="http://www.forexblog.org/wp-content/uploads/2011/04/Asian-currencies-vs-Dollar-2010-2011.jpg" title="Asian currencies vs Dollar 2010 - 2011" width="555" /></a><br /> To quote Secretary Geithner again, “This asymmetry [between nations that intervene and those that don't] in exchange rate policies creates a lot of tension. It magnifies upward pressure on those emerging-market exchange rates that are allowed to move and where capital accounts are much more open. It intensifies inflation risk in those emerging economies with undervalued exchange rates. And, finally, it generates protectionist pressures.” In short, when one country decides not to play the rules, other countries are quick to catch on. [To be fair, while the US doesn't intervene directly on behalf of the Dollar, it still deserves some blame for this <em>tension</em> because of <a href="http://www.forexblog.org/2011/04/fed-mulls-end-to-easy-money.html">QE2 and the like</a>].<br /> If any country appears to be taking these lessons to heart, however, it is China. To combat inflation, it has raised interest rates several times over the last twelve months, including yesterday’s <a href="http://online.wsj.com/article/BT-CO-20110405-707775.html">surprise 25 basis point hike</a>. Given that official inflation remains above 5% (and living here, I can tell you that the actual rate is probably 10-20%), the PBOC has no choice but to continue tightening monetary policy if it wishes to avoid social unrest. To counter the inevitable upward pressure on the Yuan, it has taken such measures as <a href="http://www.reuters.com/article/2011/03/07/us-china-overseas-deals-idUSTRE72626G20110307">prodding Chinese firms</a> to look abroad for acquisition targets. <a href="http://www.forexblog.org/wp-content/uploads/2011/04/China-inflation-rate-2005-2011.jpg"><img alt="" class="aligncenter size-full wp-image-3825" height="292" src="http://www.forexblog.org/wp-content/uploads/2011/04/China-inflation-rate-2005-2011.jpg" title="China inflation rate 2005 - 2011" width="626" /></a>China’s forex policy is designed to serve one very important end: to buttress the competitiveness of its export sector. However, there are early indications that China’s preeminent position as the world’s sweatshop may be about to slide. Anecdotal reports show that manufacturers are unnerved by wage and raw materials inflation, and are uprooting factories. In the short-term, some of this production will move inland from the coast, but even this has its limits. According to <a href="http://www.google.com/hostednews/ap/article/ALeqM5gOOWvKlQXuJhwprJTb_hxyJNCG7Q?docId=d937d801bd43432e99dc490674a3cdbd">Credit Suisse</a>, “Salaries for China’s estimated 150 million migrant workers will rise 20 to 30 percent a year for the next three to five years…’It may take a decade for China to see its export competitiveness erode, but we have seen the beginning of this happening.’ ”<br /> With this in mind, it’s clearly futile for China to continue to focus its economic policy around low-cost, labor-intensive exports. Likewise, it’s ridiculous to continue to artificially depress the Yuan, especially if it’s serious about turning it into a global reserve currency. I think Chinese policymakers recognize this, and I stand by my <a href="http://www.forexblog.org/2011/02/chinese-yuan-further-appreciation-is-inevitable.html">earlier prediction</a> that the Yuan will maintain a steady pace of appreciation for the foreseeable future.

G20 Pressures China, Despite Yuan Appreciation

Since the People’s Bank of China (PBOC) unfixed the Chinese Yuan in June, it has appreciated 4.5%. Moreover, for a handful of reasons, it ...

Read more »

“Currency Manipulation” Will Continue, Despite G20

<div>Last month, the G20 <a href="http://www.bloomberg.com/news/2011-02-21/g-20-overcomes-china-opposition-to-agree-on-yardsticks-to-gauge-imbalances.html">finally agreed</a> on the specific factors that would be used to determine whether a country was manipulating its currency. Despite being watered-down (by the usual suspects), the so-called “scorecard” is nonetheless extremely substantive. Unfortunately, the resolution will be backed only by “peer pressure,” rather than any kind of real enforcement mechanism, which means that in practice it is basically worthless.<a name="more"></a></div><div> </div>While the proximate goal of the resolution is to eliminate exchange rate manipulation, it’s ultimate goal is to minimize the risk of another economic/financial crisis. Towards that end, a country’s “budget deficit levels, the external imbalance and private savings rates” will be closely scrutinized, and will be warned if any of these factors reach levels that are deemed to be unsustainable. The idea is that an early warning system will prevent the global economy from reaching a point of disequilibrium that is so severe that crisis would be impossible to avert. <div> </div><div>Of course, the problems with this program are manifold. First of all, there are no concrete numbers. For example, it’s not clear how large a country’s national debt or trade deficit has to reach before it receives a phone call and slap on the wrist from the G20. In fact, you could argue that the same imbalances that precipitated the crisis are largely still in place, which means that some countries should have been warned yesterday.</div><div> </div><div>Second, there is no meaningful enforcement mechanism. That means that countries that disregard the resolution don’t really have anything to fear, other than the wrath of investors. In other words, if governments and Central Banks know that they can manipulate their exchange rates with impunity, what’s to stop them? Look at Japan: its public debt is the highest in the world. It runs a perennial trade surplus. Its citizens are notorious savers. And yet, when the Yen rose to a record high, which you might expect from such an imbalanced economy, the G7 (in this case) took the unusual step of <a href="http://online.wsj.com/article/BT-CO-20110321-714536.html">pushing the Yen down</a>. I’m not saying this wasn’t the right thing to do, but what kind of signal does this send to other rule breakers.</div><div> </div><div>While all emerging market countries took an active interest in exchange rates (and seek to exert some control over their currencies), China is certainly Public Enemy #1, and is the clear target of the “currency manipulation” talk. To its credit, the People’s Bank of China (PBOC) has permitted the Chinese Yuan to appreciate 20% against the Dollar (probably 30% when inflation is taken into account) over the last few years. Meanwhile, both internal government statisticians and the IMF expect its <a href="http://www.businessweek.com/ap/financialnews/D9LQAO9G0.htm">current account surplus to narrow</a> to a mere 5% in 2011, as its economy slowly rebalances.</div><div> </div><div>In this sense, I think China is a case in point that the best enforcement mechanism is <em>reality</em>. Specifically, China has reached a point where it cannot continue to pursue an economic policy based on exports, without spurring inflation and causing the inefficient allocation of domestic capital (such as in real estate). It must raise interest rates and accept the continued appreciation of the RMB is an unavoidable byproduct.</div><div> </div><div>The same goes for other countries that attempt to hold their currencies down. If they can get away with it, then so be it. If not, I can guarantee that it won’t be the G20 that forces them to change.</div>

“Currency Manipulation” Will Continue, Despite G20

Last month, the G20 finally agreed on the specific factors that would be used to determine whether a country was manipulating its currency...

Read more »

Chinese Yuan Continues to Tick Up

At the very end of 2010, the Chinese Yuan managed to cross the important psychological level of 6.60 USD/CNY, reaching the highest level since 1993. Moreover, analysts are unanimous in their expectation that the Chinese Yuan will continue rising in 2011, disagreeing only on the extent. Since the Yuan’s value is controlled tightly  by Chinese policymakers, forecasting the Yuan requires an in-depth look at the surrounding politics.<br /><a name="more"></a><br /> While American politicians chide it for not doing enough, the Chinese government nonetheless deserves some credit. It has allowed the Yuan to appreciate nearly 25% in total, which should be just enough to satisfy the 25-40% that was initially demanded. Meanwhile, over the last five years, China’s trade surplus has fallen dramatically, to <a href="http://online.wsj.com/article/BT-CO-20110117-708622.html">3.3% of GDP in 2010</a>, compared to a peak of 11% in 2007. In fact, if you don’t include trade with the US, its surplus was basically nil this year.<br /> <a href="http://www.forexblog.org/wp-content/uploads/2011/01/China-Balance-of-Trade-2001-2011.jpg"><img alt="" class="aligncenter size-full wp-image-3636" height="294" src="http://www.forexblog.org/wp-content/uploads/2011/01/China-Balance-of-Trade-2001-2011.jpg" title="China Balance of Trade 2001 - 2011" width="627" /></a>Therein lies the problem. Despite the fact that prices in Chinese exports should have risen 25% (much more if you take inflation and rising wages into account) since 2004, the <a href="http://www.census.gov/foreign-trade/balance/c5700.html">China/US trade balance has remained virtually unchanged</a>, and its current account surplus has actually widened. As a result, China’s foreign exchange reserves <a href="http://www.nytimes.com/2011/01/12/business/global/12yuan.html?src=busln">increased by a record amount in 2010</a>, bringing the total to a whopping $2.9 Trillion! (Of course, these reserves should be thought of as a <a href="http://www.ft.com/cms/s/0/962ddf12-225f-11e0-b91a-00144feab49a.html#axzz1BMNBnjwX">monetary burden</a> rather than pure wealth, to the same extent as the US Federal Reserve Board’s Balance Sheet must one day be wound down. In the context of this discussion, however, that might be a moot point).<br /> Meanwhile, China is trying to slowly tilt the structure of its economy towards domestic consumption, which is increasing by almost every measure. Its Central Bank is also slowly hiking interest rates and raising the reserve requirements of banks in order to put the brakes on economic growth and rein in inflation. Finally, it is trying to encourage internationalization of the Yuan. There now 70,000 Chinese trade companies that are permitted to settle trades in Chinese Yuan. In addition, <a href="http://online.wsj.com/article/SB10001424052748703791904576076082178393532.html?mod=djemalertNEWS">Bank of China just announced</a> that US customers will be able to open up Yuan-denominated accounts, and the World Bank became the latest foreign entity to issue an RMB-denominated “<a href="http://www.reuters.com/article/idUSTRE7040R820110105">Dim-Sum Bond</a>.”<br /> <a href="http://www.forexblog.org/wp-content/uploads/2011/01/Chinese-Yuan-Deposits-in-Hong-Kong.jpg"><img alt="" class="aligncenter size-full wp-image-3635" height="287" src="http://www.forexblog.org/wp-content/uploads/2011/01/Chinese-Yuan-Deposits-in-Hong-Kong.jpg" title="Chinese Yuan Deposits in Hong Kong" width="368" /></a><br />There is also evidence that the Chinese Government’s top leadership – with whom the US government directly negotiates – is actually pushing for a faster appreciation of the RMB but that it faces internal opposition. According to the New York Times, “The <a href="http://www.nytimes.com/2011/01/17/world/asia/17china.html?_r=1&hp">debate over revaluing the renminbi</a>… has not advanced much partly because of a fight between central bankers who want the currency to rise and ministers and party bosses who want to protect the vast industrial machine that depends on cheap exports for survival.” In fact, the Bank of China (PBOC) recently <a href="http://online.wsj.com/article/BT-CO-20110111-701941.html">warned</a>, “Factors such as the country’s trade surplus, foreign direct investment, China’s interest rate gap with Western countries, yuan appreciation expectations, and rising asset prices are likely to persist, drawing funds into the country,” while a <a href="http://online.wsj.com/article/BT-CO-20110115-700080.html">senior Chinese lawmaker pushed back</a> that a “rise in the yuan’s value won’t help the country to curb inflation.”<br /> Some analysts expect a big move in the Yuan that corresponds with this week’s US visit by China’s Prime Minister, Hu Jintao. The average call, however, is for a continued, steady rise. “China’s currency will strengthen 4.9 percent to 6.28 by the end of 2011, according to the median estimate of 19 analysts in a <a href="http://www.bloomberg.com/news/2010-12-31/yuan-advances-beyond-6-6-per-dollar-for-first-time-since-1993-on-inflation.html">Bloomberg survey</a>. That’s over double the 2 percent gain projected by 12-month non-deliverable forwards.” As I wrote in my <a href="http://www.forexblog.org/2010/12/chinese-yuan-appreciation-or-inflation.html">previous post on the Chinese Yuan</a>, however, it ultimately depends on inflation – whether it keeps rising and if so, how the government chooses to tackle it.

Chinese Yuan Continues to Tick Up

At the very end of 2010, the Chinese Yuan managed to cross the important psychological level of 6.60 USD/CNY, reaching the highest level s...

Read more »

Chinese Yuan: Appreciation or Inflation?

Based on nominal exchange rates, the Chinese Yuan has appreciated by a modest 2% against the US Dollar since the month of September (when the People’s Bank of China (PBOC) adjusted the currency peg for the first time in nearly two years). If you take inflation into account, however, the Chinese Yuan has risen by much more. In fact, if current trends persist, the Chinese Yuan exchange rate controversy might resolve itself.<br /><a name="more"></a><br /> <img alt="CNY USD 1 year chart" class="aligncenter size-full wp-image-3266" height="288" src="http://www.forexblog.org/wp-content/uploads/2010/12/CNY-USD-1-year-chart.png" title="CNY USD 1 year chart" width="512" /><br />Demands from the international community for China to appreciate its currency hinge on two related arguments. The first is that at its current level, the artificially low exchange has allowed China to build up a massive trade surplus. The second is that Chinese prices seem to be lower than they should be (when quoted in other currencies), and the economic principle of <em>Purchasing Power Parity (PPP)</em> suggests that for this discrepancy to be eliminated, the Chinese Yuan must rise.<br /> As it turns out, both of these claims are more problematic than they would appear. For example, China’s official <a href="http://www.bloomberg.com/news/2010-12-10/china-reports-more-than-estimated-november-trade-surplus-of-22-9-billion.html">trade surplus</a> is already massive, and is steadily increasing. For 2010, it will probably near $200 Billion. However, it turns out that majority of that surplus is being captured by <a href="http://english.peopledaily.com.cn/90001/90778/90861/7227376.html">foreign-funded companies</a>: “Their 112.5-billion U.S.-dollar surplus accounts for 66 percent of China’s total surplus over the past 11 months.”<br /> In addition, trade statistics are calculated in such a way that the country that assembles the finished product gets credit for the full export value of that product. By looking specifically at Apple’s popular iPhone, <a href="http://online.wsj.com/article/SB10001424052748704828104576021142902413796.html?mod=WSJ_hp_us_mostpop_read">researchers calculated</a> that the product officially contributed $2 Billion to the US trade deficit with China. When the nuances of the iPhone’s supply chain are taken into account, that figure swings to a surplus of $48 million. In both of these cases, the fact that these products are manufactured in China doesn’t detract from US GDP (though it probably does cost the US jobs). Hence, the US probably isn’t hurting as much from the weak RMB to the extent that some lobbyists insist.<br /> <img alt="iPhone US China trade deficit" class="aligncenter size-full wp-image-3267" height="357" src="http://www.forexblog.org/wp-content/uploads/2010/12/iPhone-US-China-trade-deficit.jpg" title="iPhone US China trade deficit" width="555" /><br />As for inflation, the official rate is now 5.1% on an annualized basis. Even if we accept this (and living in China, I can tell you that the actual rate is much, much higher), that means that the value of other currencies is eroding at a much faster rate than is implied by official exchange rates. That’s because a currency is only worth its purchasing power; as prices and wages in China rise, the purchasing power of the US Dollar (and other currencies) falls.<br /> The Chinese government is trying to address the problem in the form of price controls and mandated increases in supply, but it is still reluctant to rein in inflation using conventional monetary policy measures. M2 money supply in China is increasing at a rate of 20% a year, the majority of which is being spent on another boom in fixed asset investment. While the PBOC has responded by increasing the required reserve ratio of Chinese banks, it remains reluctant to raise interest rates lest it contribute to further inflows of “hot money” on more upward pressure on the Yuan. As a result, the consensus among economists is that inflation will continue rising unabated: “<a href="http://blogs.wsj.com/chinarealtime/2010/11/11/economists-react-chinas-inflation-spike/">We see</a> a strong chance of underlying price pressures continuing to build over the medium-term.”<br /> <div style="text-align: left;"><img alt="China inflation rate 2004-2010" class="aligncenter size-full wp-image-3268" height="255" src="http://www.forexblog.org/wp-content/uploads/2010/12/China-inflation-rate.jpg" title="China inflation rate 2004-2010" width="563" /><br />Unless circumstances change, then, the argument for further RMB appreciation is somewhat weak. Nonetheless, analysts remain optimistic: “A <a href="http://www.china-briefing.com/news/2010/12/17/goldman-and-nomura-rate-yuan-forwards-as-asias-most-profitable-bet-in-2011.html">Bloomberg survey</a> based on the median estimates of 20 analysts predicts the yuan to increase 6.1 percent to 6.28 percent by the end of 2011.” Given that Hu Jintao is schedule to visit the US in January – and China’s fondness for symbolic policy gestures – a token move of 1% or so before then wouldn’t be surprising. As for the predicted 6% rise next year, well, that depends on inflation.</div>

Chinese Yuan: Appreciation or Inflation?

Based on nominal exchange rates, the Chinese Yuan has appreciated by a modest 2% against the US Dollar since the month of September (when t...

Read more »

Chinese Yuan Will Not Be Reserve Currency?

In a recent editorial reprinted in The Business Insider (<a href="http://www.businessinsider.com/yuan-wont-be-worlds-reserve-currency-2010-10"><em>Here’s Why The Yuan Will Never Be The World’s Reserve Currency</em></a>), China expert Michael Pettis argued forcefully against the notion that the Chinese Yuan will be ever be a global reserve currency on par with the US Dollar. By his own admission, Pettis seeks to counter the claim that China’s rise is inevitable.<br /> The core of Pettis’s argument is that it is arithmetically unlikely – if not impossible – that the Chinese Yuan will become a reserve currency in the next few decades. He explains that in order for this to happen, China would have to either run a large and continuous current account deficit, or foreign capital inflows into China would have to be matched by Chinese capital outflows.” Why is this the case? Simply, a reserve currency must necessarily offer (foreign) institutions ample opportunity to accumulate it.<br /><a name="more"></a><br /> <img alt="China Trade Surplus 2009 - 2010" class="aligncenter size-full wp-image-3186" height="269" src="http://www.forexblog.org/wp-content/uploads/2010/11/China-Trade-Surplus-2009-2010.jpg" title="China Trade Surplus 2009 - 2010" width="450" /><br />However, as Pettis points out, the structure of China’s economy is such that foreigners don’t have such an opportunity. Basically, China has run a current account/trade surplus, which has grown continuously over the last decade. During that time, its Central Bank has accumulated more than $2.5 Trillion in foreign exchange reserves in order to prevent the RMB from appreciating. Foreign Direct Investment, on the other hand, averages 2% of GDP and is declining, not to mention that “a significant share of those inflows may actually be mainland money round-tripped to take advantage of capital and tax regulations.”<br /> For this to change, foreigners would need to have both a reason and the opportunity to hold RMB assets. The reason would come from a reversal in China’s balance of trade, and the use of RMB to pay for the excess of imports over exports, which would naturally imply a willingness of foreign entities to accept RMB. The opportunity would come in the form of deeper capital markets, a complete liberalization of the exchange rate regime (full-convertibility of the RMB), and the elimination of laws which dictate how foreigners can invest/lend in China. This would likewise an imply a Chinese government desire for greater foreign ownership.<br /> <img alt="China FDI 2009-2010" class="aligncenter size-full wp-image-3187" height="355" src="http://www.forexblog.org/wp-content/uploads/2010/11/China-FDI-2009-2010.jpg" title="China FDI 2009-2010" width="450" /><br /> How likely is this to happen? According to Pettis, <em>not very</em>. China’s financial/economic policy are designed both to favor the export sector and to promote access to cheap capital. In practice, this means that interest rates must remain low, and that there is little impetus behind the expansion of domestic consumption. Given that this has been the case for almost 30 years now, this could prove almost impossible to change. For the sake of comparison, consider that despite two “lost decades,” Japan nonetheless continues to promote its export sector and maintains interest rates near 0%.<br /> Even if the Chinese economy continues to expand and re-balances itself in the process (a dubious possibility), Pettis estimates that it would still need to increase the rate of foreign capital inflows to almost 10% of GDP. If economic growth slows to a more sustainable level and/or it continues to run a sizable trade surplus, this figure would rise to perhaps 20%. In this case, Pettis concedes, “we are also positing…a radical change in the nature of ownership and governance in China, as well as a radical redrawing of the role of the central and local governments in the local economy.”<br /> So there you have it. The political/economic/financial structure of China is such that it would be arithmetically very difficult to increase foreign accumulation of RMB assets to the extent that the RMB would be a contender for THE global reserve currency. For this to change, China would have to embrace the kind of reforms that go way beyond allowing the RMB to fluctuate, and strike at the very core of the CCP’s stranglehold on power in China.<br /> If that’s what it will take for the RMB to become a fully international currency, well, then it’s probably too early to be having this conversation. Perhaps that’s why the Asian Development Bank, in a <a href="http://aric.adb.org/grs/papers/Future_Global_Reserve_System.pdf">recent paper</a>, argued in favor of modest RMB growth: “sharing from about 3% to 12% of international reserves by 2035.” This is certainly a far cry from the “10 years” <a href="http://www.reuters.com/article/usDollarRpt/idUSL64476620090606">declared by Russia’s finance minister</a> and tacitly supported by Chinese economic policymakers.<br /> The implications for the US Dollar are clear. While it’s possible that a handful of emerging currencies (Brazilian Real, Indian Rupee, Russian Ruble, etc.) will join the ranks of the international currencies, none will have enough force to significantly disrupt the status quo. When you also take into account the economic stagnation in Japan and the UK, as well as the political/fiscal problems in the EU, it’s more clear than ever that the Dollar’s share of global reserves in one (or two or three) decades will probably be only slightly diminished from its current share.

Chinese Yuan Will Not Be Reserve Currency?

In a recent editorial reprinted in The Business Insider ( Here’s Why The Yuan Will Never Be The World’s Reserve Currency ), China expert Mi...

Read more »

China Diversifies Forex Reserves

China’s foreign exchange reserves continue to surge. As of September, the total stood at $2.64 Trillion, an all-time high. However, it’s becoming abundantly clear that China is no longer content for Dollar-denominated assets to represent the cornerstone of its reserves. Instead, it has embarked on a campaign to further diversify its reserves, with important implications for the currency markets.<br /><a name="more"></a><br /> <img alt="China Forex Reserves 2010" class="aligncenter size-full wp-image-3140" height="281" src="http://www.forexblog.org/wp-content/uploads/2010/10/China-Forex-Reserves-2010.jpg" title="China Forex Reserves 2010" width="234" /><br /> Despite China’s allowing the Chinese Yuan to appreciate (or perhaps because of it), hot money continues to flow in – nearly $200 Billion in the the third quarter alone. Foreign investors are taking advantage of strong investment prospects, rising interest rates, and the guarantee of a more valuable currency. In order to prevent the inflows from creating inflation and putting even more upward pressure on the RMB, the Central Bank “sterilizes” the inflows by purchasing an offsetting quantity of US Dollars and other foreign currency.<br /> Since the Central Bank does not release precise data on the breakdown of its reserves, analysts can only guess. Estimates range from the world average of 62% to as high as 75%. At least $850 Billion (this is the official tally; due to covert buying through offshore accounts, the actual total is probably higher) of its reserves are held in US Treasury securities. It also controls a $300 Billion Investment Fund, which has made very public investments in natural resource companies around the world. The allocation of the other $1.5 Trillion is a matter of speculation.<br /> Still, China has stated transparently that it wants to diversify its reserves into emerging market currencies, following the global shift among private investors. Investment advisers praise China for its shrewdness, in this regard: “The <a href="http://www.bloomberg.com/news/2010-10-11/china-seeks-to-add-emerging-market-currencies-to-foreign-exchange-reserves.html">Chinese authorities are some of the smartest in the world</a>. If you look at the fundamentals of a lot of these emerging markets, they are considerably better than developed markets. Who wants to be holding U.S. dollars at this stage?” However, these investments serve two other very important objectives.<br /> The first is diplomatic/political. When China recently signed an <a href="http://online.wsj.com/article/BT-CO-20101008-707616.html">agreement with Turkey</a> to conduct bilateral trade in Yuan and Lira (following similar deals with Brazil and Russia), it was interpreted as an intention snub to the US, since trade is currently conducted in US Dollars. In addition, by funding projects in other emerging markets through a combination of loans investments, China is able to curry favor with host countries, as well as to help its own economy at the same time. The second is financial: by buying the currencies of trade rivals, China is able to make sure that its own currency remains undervalued. This year, it has already purchased more than $5 Billion in South Korean bonds, and perhaps $20 Billion in Japanese sovereign debt, sending the Won and the Yen skywards in the process.<br /> China’s purchases of Greek and (soon) Italian debt serve the same function. It is seen as an ally to financially troubled countries, while its efforts help to keep the Euro buoyant, relative to the RMB. <a href="http://online.wsj.com/article/SB10001424052748704657304575539423408190924.html?mod=googlenews_wsj">According to Chinese Premier Wen JiaBao</a>, “China firmly supports Greece’s efforts to tackle the sovereign debt crisis and won’t cut its holdings of European bonds.”<br /> For now, China remains deeply dependent on the US Dollar, and is still very vulnerable to a sudden depreciation it its value. For as much as it wants to diversify, the supply of Dollars and the liquidity with which they can be traded means that it will continue to hold the bulk of its reserves in Dollar-denominated assets. In addition, the Central Bank has no choice but to continue buying Dollars for as long as the RMB remains pegged to it. At some point in the distant future, the Yuan will probably float freely, and China won’t have to bother accumulating foreign exchange reserves, but that day is still far away. For as long as the peg remains in place, the Dollar’s status as global reserve currency is safe.

China Diversifies Forex Reserves

China’s foreign exchange reserves continue to surge. As of September, the total stood at $2.64 Trillion, an all-time high. However, it’s b...

Read more »

Betting on China Via Australia

There are plenty of investors that think betting on China is as close to a sure thing as there could possibly be. The only problem is that investing directly in China’s economic freight train is complicated, opaque, and sometimes impossible. The Chinese government maintains strict capital controls, prohibits foreigners from directly owning certain types of investment vehicles, and prevents the Chinese Yuan from appreciating too quickly, if at all. For those that want exposure to China without all of the attendant risks, there is a neat alternative: the Australian Dollar (AUD).<br /><a name="more"></a><br /> Those of you that regularly read my posts and/or follow the forex markets closely should be aware of the many correlations that exist between currencies and other financial markets, as well as between currencies. In this case, there would appear to be a strong correlation between Chinese economic growth and the Australian Dollar. If the Chinese Yuan were able to float freely, it might rise and fall in line with the AUD. Since the Yuan is fixed to the US Dollar, however, we must look for a more roundabout connection. HSBC research analysts used Chinese electricity consumption as a proxy for Chinese economic activity (why they didn’t just use GDP is still unclear to me), and discovered that it fluctuated in perfect accordance with the Australian Dollar.<br /> <div style="text-align: left;"><img alt="Australian Dollar and Chinese electricity consumption 1990-2008" class="aligncenter size-full wp-image-3106" height="285" src="http://www.forexblog.org/wp-content/uploads/2010/10/Australian-Dollar-and-Chinese-electricity-consumption-1990-2008.gif" title="Australian Dollar and Chinese electricity consumption 1990-2008" width="550" /><br />Before I get ahead of myself, I want to explain why one would even posit a connection between China and the Aussie in the first place. There are actually a few reasons. First, Australia is economically part of Asia: “Today, 43 per cent of <a href="http://www.theaustralian.com.au/business/resource-driven-economy-leads-the-charge/story-e6frg8zx-1225938887771">Australia’s total merchandise trade</a> is with north Asia. A further 15 per cent is with Southeast Asia.” Second, Australia’s economy is driven by the extraction and sale of natural resources, of which China is a major buyer and investor: “In 2008-9, China was the biggest investor in the key resource sector with $26.3bn involvements approved, 30 per cent of the total.” Third, Chinese demand has come to dictate the prices of many such resources, causing them to rise continuously. Thus, Australia’s natural resource exports to countries other than China still draw strength (via high commodity prices) from Chinese demand.</div>As one analyst summarized, “<a href="http://online.wsj.com/article/SB10001424052748703597204575484142156756392.html">China is buying raw materials</a> from Australia in leaps and bounds, and that’s what’s driving that currency’s growth.” Sounds like an Open and Shut case. In fact, this presumed correlation has become so entrenched that any indication that China is trying to cool its own economy almost always prompts a reaction in the Aussie. To be sure, warnings that China’s annual legislative conference (scheduled for October 17) would produce a consensus call for a tightening of economic policy have made some forecasters more conservative. Still, as long as the Chinese economy remains strong, the Australian Dollar should follow.<br /> It’s worth pointing out that the correlation between the Aussie and the Chinese economy doesn’t exist in a vacuum. For example, the Australian Dollar has also closely mirrored the S&P 500 over the last decade, which suggests that global economic growth (and higher commodity prices) are as much of a factor in the Aussie’s appreciation as is Chinese economic activity. The Aussie is also vulnerable to a decline in risk appetite, like the kind that took place during the financial crisis and flared up again as a result of the EU Sovereign debt crisis. During such periods, Chinese demand for commodities becomes irrelevant.<br /> <div style="text-align: left;"><img alt="AUD USD 2006-2010" class="aligncenter size-full wp-image-3107" height="253" src="http://www.forexblog.org/wp-content/uploads/2010/10/z.png" title="AUD USD 2006-2010" width="576" /><br />On the other hand, part of the reason the Australian Dollar has surged 10% since September and 20% since June is because other countries’ Central Banks (such as China) have increased their interventions on behalf of their respective currencies. Australia is one of a handful of countries whose Central Bank not only hasn’t actively tried to depress its currency, but whose monetary policy (via interest rate hikes) actually invites further appreciation. As the Aussie closes in on parity and Australian exporters and tourism operators become more vocal about the impact on business, however, the Reserve Bank of Australia (RBA) might be forced to act.</div>

Betting on China Via Australia

There are plenty of investors that think betting on China is as close to a sure thing as there could possibly be. The only problem is that ...

Read more »

RMB Appreciation Accelerates, but Dollar Peg Remains in Place

The Chinese Yuan has touched a new high, at 6.69 USD/CNY. Given that the Yuan has still only risen about 2% since the peg was officially loosened in June -  with most of that appreciation taking place in the last couple weeks – there still remains intense pressure on China to do more.<br /> Last week’s intervention by the Bank of Japan diverted a tremendous amount of attention towards the Yuan. In fact, many analysts have argued that it is only because of the Yuan-Dollar peg (itself, as well as the Chinese purchases of Yen assets that it engendered) that Japan was forced to act: ” ‘<a href="http://online.wsj.com/article/BT-CO-20100915-714047.html">Countries see</a> that getting involved in currency manipulation is a way to give themselves an advantage’…’China, their actions affected Japan, and Japan is affecting us.’ ” The Yen intervention could also force the G20 to re-focus its attention on the Yuan, and at least devote some discussion to it at the next summit.<br /><a name="more"></a><br /> <img alt="CNY USD 1 Year Chart 2010" class="aligncenter size-full wp-image-3055" height="288" src="http://www.forexblog.org/wp-content/uploads/2010/09/1y.png" title="CNY USD 1 Year Chart 2010" width="512" /><br /> It should be noted that the two soundbites above both emanated from US Congressmen, which is important because the US government is currently mulling action on the Yuan currency peg. Politicians are growing tired by the Treasury Department’s repeated failure to call China a “Currency Manipulator,” which would require diplomatic talks and even trade sanctions. The Treasury will have an opportunity redeem itself in its next report on foreign exchange, due out on October 15, but it is expected that the report will either be delayed or released without adequately addressing the undervalued Yuan.<br /> In fact, <a href="http://www.bloomberg.com/news/2010-09-16/geithner-says-china-needs-to-allow-significant-sustained-gains-in-yuan.html">Treasury Secretary Geithner testified before Congress</a> last week, and at least admitted that something needed to be done: “The pace of appreciation has been too slow and the extent of appreciation too limited. We have to figure out ways to change behavior.” However, this was only in response to acerbic criticism – (<a href="http://www.nytimes.com/2010/09/17/business/17geithner.html?partner=rss&emc=rss">Senator Schumer told him</a>, “I’m increasingly coming to the view that the only person in this room who believes China is not manipulating its currency is you.”) – and he ultimately failed to outline a timetable/blueprint for action. Despite the consensus among politicians (<a href="http://www.bloomberg.com/news/2010-09-21/china-calls-yuan-pressure-unwise-after-obama-criticizes-lack-of-progress.html">and President Obama</a>) that the currency peg is harmful to the US economy, Geithner made it clear that the Treasury Department continues to favor unilateral action towards dealing with problem, without Congressional intervention. For now, then, politicians are probably relegated to <a href="http://blogs.wsj.com/marketbeat/2010/09/17/26855/">saber-rattling and name-calling</a>.<br /> China’s response to this charade has been predictable. Trade representatives hinted that China wouldn’t bow to external pressure, and that any attempt at “punishment” would be met with countervailing actions. China also questioned the economics between arguments that the Dollar peg contributes to trade imbalance, calling such claims “groundless.” This position is actually supported by the notion that while the Yuan appreciated by 20% against the Dollar from 2005-2008, the US/China trade deficit actually widened.<br /> In practice, China is likely to stick to its policy of gradual Yuan appreciation, or a few reasons. First of all, while Chinese policymakers know that they don’t need to wholly appease US politicians, they at least need to pretend that they are listening. It’s true that the US is dependent on Chinese products and its <a href="http://online.wsj.com/article/BT-CO-20100916-708301.html">purchases of Treasury Bonds</a>. However, it is arguably just as dependent on the US to buy its exports, which promotes employment and social stability, and it is <a href="http://www.csmonitor.com/World/Asia-Pacific/2010/0917/Why-some-economists-see-a-looming-US-China-trade-war">keen to avoid a trade war</a> if possible.<br /> Second, a long-term appreciation of the RMB is actually in China’s best interest. If it wants to spur domestic consumption and promote more value-added manufacturing, it will need a more valuable currency. Outbound M&A, especially involving natural resource companies, will also be more economical if the Yuan is worth more. Also, if China has any serious ambitions of turning the Yuan into a global reserve currency, it will need to create capital markets that are deeper and more liquid, which it is currently unmotivated to do, lest it spur demand for Yuan by foreign institutional investors.<br /> Finally, China should let the Yuan appreciate because it is financially gainful to do so. As I mentioned above, its trade surplus with the US has widened over the last few years as prices for its exports grow along with quantity. Meanwhile, prices for imports and prices paid for commodities and other natural resources have declined in Yuan-terms. For that reason, I think China will probably continue to stick its current policy, and allow the RMB to continue to slowly inch up.

RMB Appreciation Accelerates, but Dollar Peg Remains in Place

The Chinese Yuan has touched a new high, at 6.69 USD/CNY. Given that the Yuan has still only risen about 2% since the peg was officially l...

Read more »

Chinese Yuan has Hardly Budged

The frequency of <a href="http://www.forexblog.org/category/chinese-yuan-rmb">my reports on the Chinese Yuan</a> is admittedly much higher than it used to be. Why? Call it disbelief. More than two months have passed since China revalued its currency, and after a rapid 1% appreciation, the RMB has actually fallen back. Today, it stands only .5% higher against the Dollar compared to June 18. On a trade-weighted basis, it is actually 2.3% lower. What is going on?!<br /><a name="more"></a><br /> <img alt="Chinese Yuan Revaluation 2010" class="aligncenter size-full wp-image-2988" height="281" src="http://www.forexblog.org/wp-content/uploads/2010/09/201034fnc130.gif" title="Chinese Yuan Revaluation 2010" width="290" /><br /> It can foremost be attributed to a disconnect between Chinese words and Chinese action. While The People’s Bank of China (PBOC) purportedly supports a stronger, flexible Yuan (“<a href="http://www.economist.com/node/16847852?story_id=16847852">Adopting a more flexible exchange-rate regime</a> serves China’s long-term interests as the benefits…far exceed the cost in reorganising industries and removing outdated capacities.”), in practice, it has prevented the currency from budging. On numerous occasions since supposedly allowing the RMB to appreciate, it has intervened in the forex markets through various shadow dealers to prevent this very outcome.<br /> In fact, China has increased its purchases of South Korean and Japanese sovereign debt, ostensibly as part of its diversification strategy, but more likely to put upward pressure on those currencies. “<a href="http://online.wsj.com/article/NA_WSJ_PUB:SB10001424052748703791804575439093644614592.html">Data from Japan’s Ministry of Finance</a> show that China bought a net 1.73 trillion yen ($20.3 billion) of Japanese government bonds in the first half of this year, compared with a net sale of 5.9 billion yen ($69 million) a year earlier. That strong demand has been a key factor strengthening the yen in recent weeks.” This could have broad implications, since in the last quarter, China accumulated $81 Billion in new forex reserves, and seems intent on further diversifying out of US Dollar-denominated assets.<br /> <img alt="China Diversifies Forex Reserves" class="aligncenter size-full wp-image-2989" height="216" src="http://www.forexblog.org/wp-content/uploads/2010/09/China-Diversifies-Forex-Reserves.png" title="China Diversifies Forex Reserves" width="423" /><br />China’s general obstinacy towards in dealing with the Yuan is baffling to market observers, especially given the trade surplus of nearly $30 Billion in June, its largest since January of 2009. In fact, China can be seen moving backwards. It recently inaugurated a pilot program that will allow exporters to hold offshore accounts of foreign currency, which might be expected to relieve some of the upward pressure on both the Yuan and on China’s foreign exchange reserves: “<a href="http://online.wsj.com/article/SB10001424052748704147804575454973813623654.html">If you don’t force firms</a> to surrender their foreign-exchange proceeds, then they won’t be exchanged for renminbi, which is a source of appreciation pressure.” In this way, China can both limit speculative capital inflows (even by domestic investors) and inflation.<br /> Foreign governments, led by the US, are still threatening action. Senators and Congressmen continue to harp on the issue (it is election season, after all), and are still threatening to slap a tariff on all Chinese imports. However, their efforts are being undermined by both the Department of Treasury (which refuses to label China a “currency manipulator”) and the <a href="http://www.washingtonpost.com/wp-dyn/content/article/2010/08/31/AR2010083105493.html">Department of Commerce</a>, which recently determined that the application of a broad-based tariff on all Chinese imports would violate its mandate.<br /> I have always been cynical about China’s forex policy, on the basis that it is self-interested and disingenuous, and I think the fact that it remains pegged to the USD confirms that sentiment. In the end, China won’t bow to international pressure. It will only allow the Yuan to appreciate after it has determined that its economy won’t be negatively impacted, and even then, the pace will be glacial.

Chinese Yuan has Hardly Budged

The frequency of my reports on the Chinese Yuan is admittedly much higher than it used to be. Why? Call it disbelief. More than two months...

Read more »

China Currency Revaluation: More Than Just the Yuan at Stake

I concluded my last post (<a href="http://www.forexblog.org/2010/08/euro-recovery-paradigm-shift-confirmed.html"><em>Euro Recovery: Paradigm Shift Confirmed</em></a>) by musing about how interesting it is that nobody has taken credit for predicting/profiting from the sudden reversal in forex markets, whereby the Euro has surged and the Dollar has tanked. Two days later, I think I can offer an explanation: China.<br /> That’s right. The force behind the sudden sea change might not be private investors, which up until the spike entrenched itself as a full-fledged connection, remained firmly behind the declining Euro. Instead, it seems quite reasonable that China – via its sovereign wealth fund, which is charged with investing its foreign exchange reserves – might be the responsible party.<br /><a name="more"></a><br /> That China is buoying the Euro would make sense on a couple fronts. First of all, it would explain the mysterious silence behind the rally. China is naturally secretive in pretty much everything it does, especially in the way it conducts currency policy and manages its forex reserves. That China hasn’t even formally announced, let alone bragged about, “diversifying” its reserves, makes perfect sense.<br /> More importantly, that China is responsible also makes sense from a strategic standpoint. China has long spoken about its intentions to change the allocation of its forex reserve holdings, and in hindsight, its timing was perfect. In the beginning of June, the Euro stood at a multi-year low, and the price of US Treasury Bonds stood at a multi-year high. Thus, China’s sovereign wealth fund was able to simultaneously lock in some profits from lending to the US and dissipate risk by swapping US assets for those denominated in Euros and Yen. “<a href="http://online.wsj.com/article/SB10001424052748703589404575418503848293076.html">China has already bought</a> $20 billion worth of yen financial assets this year, almost five times as much as it did in the previous five years combined.” [<a href="http://online.wsj.com/article/SB10001424052748703988304575413632278801888.html?mod=googlenews_wsj">Analysts have noted</a> that buying Yen also achieves the peripheral end of making Japanese exports less competitive relative to those from China].<br /> Moreover, China can achieve this diversification without influencing the value of the Yuan, since Dollars can be exchanged directly for Yen and Euros. That is important, since the RMB is still effectively pegged to the Dollar. Speaking of which, the Yuan has hardly budged since its 1% revaluation in June. On a trade-weighted basis, it has actually fallen.<br /> <img alt="China's Current-Account Balance as a Share of GDP 2004-2015" class="aligncenter size-full wp-image-2921" height="497" src="http://www.forexblog.org/wp-content/uploads/2010/08/Chinas-Current-Account-Balance-as-a-Share-of-GDP-2004-2015.gif" width="275" /><br />Pressure continues to mount on China to allow the RMB to appreciate. As a result of the 1% nudge in June, <a href="http://dealbook.blogs.nytimes.com/2010/08/05/despite-losses-asian-hedge-funds-draw-money/">speculative <em>hot money</em></a> is now flowing into China at an increasing rate, because investors are “thematically looking for ways that they can participate in the currency markets in China.” They are supported by the <a href="http://online.wsj.com/article/SB10001424052748703578104575396953580078456.html">IMF</a>, which most recently called on China to re-balance its economy away from exports and towards trade. Its report included predictions that China’s currency account / trade surplus will continue to rise, seemingly for as long as the RMB remains undervalued. Due to pressure from China, however, it removed precise figures on the recommended extent of said revaluation.<br /> According to a <a href="http://blogs.wsj.com/chinarealtime/2010/08/09/sharp-slowdown-in-china%E2%80%99s-exports-seen/">consensus of analysts</a>, China’s exports were probably lower in the month of July, which could give the Central Bank pause in allowing the RMB to rise too much too soon. Instead, it has <a href="http://www.bloomberg.com/news/2010-07-22/china-may-publish-rate-to-manage-yuan-versus-basket-of-currencies-hu-says.html">announced</a> that it will make a more sincere effort to tie the Yuan to a basket of currencies, rather than just the Dollar. ” ‘The yuan should be kept stable at a reasonable and balanced level overall, while it may have two-way moves against particular currencies,’ Hu [XiaoLian, Deputy Governor] said, adding that the composition of the central bank’s currency basket should be mainly based on trade weightings.”<br /> <img alt="USD CNY 3 Month Chart" class="aligncenter size-full wp-image-2920" height="288" src="http://www.forexblog.org/wp-content/uploads/2010/08/USD-CNY-3-Month-Chart.png" width="512" /><br />Going forward, then, the Yuan will probably remain basically stable against the Dollar. As China moves towards a trade-weighted peg, however, it is conceivable that it will continue to buy Euros (and Yen, for spite) against the Dollar. As this could have a confounding effect on currency markets, traders should plan accordingly.

China Currency Revaluation: More Than Just the Yuan at Stake

I concluded my last post ( Euro Recovery: Paradigm Shift Confirmed ) by musing about how interesting it is that nobody has taken credit for...

Read more »

Reflecting on the Chinese Yuan Revaluation

Today marks the one-month anniversary of China’s decision to remove the Yuan’s peg to the Dollar, and allow it to float. Now that the news has had a chance to wend its way through the financial markets, I think it’s time both to reflect and to forecast.<br /> Over the last month, the Chinese RMB has appreciated by slightly less than 1% against the Dollar, although most of that jump took place in the day that followed the June 19 announcement. After the initial excitement faded, a sense of disappointment set in as it became clear that China had no intention of allowing the RMB to appreciate rapidly: “<a href="http://www.financialpost.com/news/Yuan+appreciation+guaranteed/3181424/story.html">The subsequent appreciation</a> of the yuan against the dollar is likely to be small, perhaps just a few percent over the remainder of the year.” In fact, futures prices reflect only an additional 1.5% appreciation over the next 12 months.<br /><a name="more"></a><br /> <img alt="RMB USD June 2011 Futures" class="aligncenter size-full wp-image-2876" height="289" src="http://www.forexblog.org/wp-content/uploads/2010/07/RMB-USD-June-2011-Futures.bmp" width="596" /><br /> Due both to its slow speed and small scope, the revaluation could conceivably benefit the Chinese economy. That’s because in the short-term, a more expensive currency will mean higher prices paid for exports. The quantity of exports is unlikely to decline, such that total export revenues could actually increase. According to one analyst, “<a href="http://knowledge.wharton.upenn.edu/article.cfm?articleid=2538">With Chinese imports</a>, there are no substitutes in the short term. Maybe in 10 years, importers will have a choice, but right now they will just have to pay more. No other country…can build a manufacturing base and all the infrastructure that you need — transportation, energy, the entire value chain to the final good — takes many years.” As if on cue, China’s trade surplus expanded in June, in spite of the revaluation of the Yuan.<br /> <div style="text-align: center;"><img alt="China Trade Balance 2004-2010" class="size-full wp-image-2875 aligncenter" src="http://www.forexblog.org/wp-content/uploads/2010/07/China-Trade-Balance-2004-2010.bmp" /></div>As a result, American manufacturers and other vested interests have announced that they will <a href="http://www.reuters.com/article/idUSN0911035120100709">continue to lobby</a>the US government to pressure China on the currency issue, on the basis that the undervalued RMB is eroding both the US economy and the labor market. Argued the director of the Peterson Institute for International Economics, “The case for a substantial increase in the value of the renminbi is thus clear and overwhelming. An appreciation of 25% to 40% is needed to cut China’s global [account] surplus even to 3% to 4% of its GDP. This realignment would produce a reduction of $100 billion to $150 billion in the annual U.S. current account deficit.” It might also help to restore the <a href="http://krugman.blogs.nytimes.com/2009/12/31/macroeconomic-effects-of-chinese-mercantilism/">estimated 1.4 million jobs</a>that have been lost due to China’s forex policy. According to analysts, however, political infighting make it unlikely that any new law or punitive tariffs will be imposed anytime soon.<br /> At the very least, China will continue to make the Yuan more flexible, so that one day it can float freely. It has already moved to facilitate trade settlement in Yuan, and analysts expect ” ‘<a href="http://www.reuters.com/article/idUSTRE6650G620100706">more than half</a> of China’s total trade flows, primarily bilateral trade with emerging markets, to be settled in renminbi in the next three to five years.’ ” China is also making it more attractive for foreign investors to hold Yuan, by loosening controls that govern Chinese capital markets and creating <a href="http://blogs.wsj.com/chinarealtime/2010/07/01/polishing-the-yuan/">new investment vehicles</a> that will cater directly to foreigners. In the mean time, holding RMB is pretty unattractive given both “the <a href="http://www.economist.com/node/16432856?story_id=16432856&source=hptextfeature">hassle</a> of getting money in and out of China” and the low rates offered by Chinese money market funds.<br /> <img alt="USD CNY 5 year chart" height="259" src="http://www.forexblog.org/wp-content/uploads/2010/07/USD-CNY-5-year-chart.png" width="461" /><br /> As for the impact on the rest of the forex market, I think that commodity currencies and growth currencies could come out ahead. The move signals an implicit confidence in the global economic recovery and can perhaps be seen as a harbinger for high commodity prices: In addition, it will “<a href="http://online.wsj.com/article/SB127760334654511011.html">provide a boost</a>to U.S. exports, employment, earnings and growth, reinforcing the case for growth sustainability at a time when investors are more fearful than they were in April.” The US Dollar, on the other hand, could emerge as one of the big losers. Already, China’s forex reserve growth has slowed to the <a href="http://www.businessweek.com/news/2010-07-12/china-currency-reserves-increase-least-in-11-years.html">weakest pace in 11 years</a>. This trend will probably continue, since smaller purchases of Dollars will be required to maintain the floating peg. In fact, the Euro’s recovery against the Dollar has coincided mysteriously with the revaluation of the Yuan. While this is probably just a coincidence, it is nonetheless symptomatic of a declining role for the Dollar as the world’s reserve currency. But that is a topic for another day…

Reflecting on the Chinese Yuan Revaluation

Today marks the one-month anniversary of China’s decision to remove the Yuan’s peg to the Dollar, and allow it to float. Now that the news ...

Read more »

China Revalues RMB….by .4%

It was only last week that I mused about “<a href="http://www.forexblog.org/2010/06/further-delays-in-rmb-appreciation.html">Further Delays in RMB Revaluation</a>.” Lo and behold, over the weekend, the Central Bank finally budged, by pledging to the members of the G20 that it would ” ‘<a href="http://www.nytimes.com/2010/06/22/business/global/22yuan.html?hp">proceed further with reform</a>‘ of the exchange rate and ‘enhance’ flexibility.” Upon reading this, I suppose I should have felt stupid.<br /><a name="more"></a><br /> Still, I wondered whether the move was aimed as a political sop designed to appease Western countries, rather than a meaningful change in China’s forex policy. My suspicions were confirmed on Monday, when the markets opened, and the RMB jumped by a pathetic .4%. All of those who had been hoping for an expecting an instant revaluation a la the 5% jump in 2005 were sadly disappointed.<br /> Most commentators shared my cynicism about the move. According to <a href="http://www.chinapost.com.tw/china/business/2010/06/22/261730/Goldmans-ONeill.htm">Goldman Sachs Group Chief Global Economist Jim O’Neill</a>, ” ‘It’s pretty astute timing. The timing of it is clearly aimed at the G-20 meeting, which indirectly links to the whole renewed thrust in Congress with protectionist steps against China.’ ” If this was in fact China’s intention, it backfired, since it only succeeding only in bringing increased attention to the still-undervalued Yuan. <a href="http://online.wsj.com/article/BT-CO-20100621-712939.html?mod=WSJ_latestheadlines">Senator Sherrod Brown</a> called the appreciation ” ‘a drop in a huge bucket….We’ve seen China take actions like this before when the spotlight is on, and then revert back to old tricks.” Thus, he and Senator Charles Schumer have announced that they will move forward with a bill to punish China, unless the RMB is allowed to significantly appreciate.<br /> By the Central Bank of China’s own admission, this is unlikely. Instead, it will continue to “<a href="http://www.nytimes.com/2010/06/21/business/global/21yuan.html?pagewanted=2&src=mv">keep the renminbi exchange rate</a> at a reasonable and balanced level of basic stability.” In other words, the RMB is still pegged squarely to the US Dollar. It is neither freely floating nor is it pegged to a basket of currencies (in which case it could conceivably appreciate faster against the Dollar, due to the weak Euro). It is technically allowed to rise and fall on a daily basis within a .5% ban, but even this is controlled tightly by the Central Bank, via the so-called <em>Central Parity Rate</em>. If the rate fluctuates too much, state-owned companies often intervene in the markets at the behest of the Central Bank. <em>Legitimate</em> market participants are heavily constrained by a <a href="http://online.wsj.com/article/SB10001424052748704256304575320520424437874.html?mod=WSJ_hpp_MIDDLENexttoWhatsNewsThird">rule</a> that requires them to square all of their positions at the end of every trading session, such that making long-term bets on the RMB’s appreciation would be impossible.<br /> <div style="text-align: left;"><img alt="RMB Revaluation Chart June 2010" class="aligncenter size-full wp-image-2815" height="227" src="http://www.forexblog.org/wp-content/uploads/2010/06/RMB-Revaluation-Chart-June-2010.bmp" width="460" /><br />Not that it matters. In the US, where it is legal to make long-term bets on the RMB (via futures contracts), investors are still only projecting a 1.8% appreciation (2.2% relative to the RMB’s pre-revaluation level) over the next year, and a 2.9% appreciation by the end of 2011. In the end, there just isn’t a lot of confidence that China will voluntarily act in a way that is contrary to its own short-term economic interests.</div>To be sure, there is a possibility that the RMB will be allowed to steadily appreciate, in which case there would be <a href="http://blogs.wsj.com/marketbeat/2010/06/21/asset-by-asset-what-does-yuan-news-mean/">real implications for other financial markets</a>. If the past is any consideration, however, the RMB will rise only modestly against the Dollar, and even more modestly on a trade-weighted basis. Its economy will remain overheated and imbalanced, and if it was <a href="http://online.wsj.com/article/SB10001424052748704895204575320482872633538.html">headed towards collapse</a> prior to this latest change, it certainly still is.

China Revalues RMB….by .4%

It was only last week that I mused about “ Further Delays in RMB Revaluation .” Lo and behold, over the weekend, the Central Bank finally bu...

Read more »

Further Delays in RMB Appreciation

<div style="text-align: left;">Throughout 2010, I have <a href="http://www.forexblog.org/category/chinese-yuan-rmb">continuously reported</a> on the apparent inevitability of the Chinese Yuan appreciation. That the currency still remains firmly fixed in place against the Dollar is a testament not only to the unpredictability of forex, but also to the doggedness of Chinese officials.<a name="more"></a></div><div> </div><div>It seemed that China’s policymakers were all but set in February to allow the currency to resume its upward path (its appreciation was halted in 2008). If anything, the case for appreciation is stronger now than it was then. China’s economy grew by a blistering 11.9% in the first quarter. The bilateral trade surplus with the US has widened on the basis of strong export growth. Inflation has exploded, and there is a property bubble that refuses to cool.</div><div> </div><div>Allowing the RMB to appreciate would cool China’s economy and presumably induce a moderation in inflation. In the short-term, it would lead to a slight expansion in the trade surplus (since prices would rise, but quantity would remain unchanged), but this would also moderate over the medium term. Decoupling from the Dollar would also enable China to pursue a more flexible monetary policy; in this case, that means raising interest rates to cool the property bubble as well as the economy at large. As Treasury Secretary <a href="http://imarketnews.com/node/14798">Timothy Geithner</a> himself has noted, ” ‘It’s in China’s interest to move.’ “</div><div> </div><div>In the same speech, Secretary Geithner conceded that China is still dragging its heels: ” ‘I do not know if we are at the point now where we will see meaningful progress in the short-term.’ ” This inkling was confirmed by the <a href="http://www.businessweek.com/news/2010-06-14/china-says-yuan-rise-can-t-solve-sino-u-s-trade-gap-update1-.html">Chinese Foreign Ministry</a>, “China will reform its exchange-rate mechanism based on developments in the global economy and its own economic performance.” Chinese President Hu JinTao, meanwhile, has personally <a href="http://online.wsj.com/article/SB10001424052748704113504575263700153952926.html?mod=WSJ_Markets_section_Currencies">pledged</a> to a visiting delegation from the US State Department to “continue reform of his country’s exchange-rate regime.”</div><div> </div><div>This isn’t doing much to assuage American lawmakers, whom are currently being slighted by both sides. While China irks Congress by refusing to adjust the RMB, the Treasury Department is also irritating it by both refusing to label China a currency manipulator and by not establishing a deadline for appreciation. As a result, “There is a <a href="http://imarketnews.com/node/15080">broad consensus in Congress</a> for a simple proposition: ‘China is not acting in good faith and is aggressively engaged in a series of troubling and downright protectionist policies that put our economic relationship at risk.’ ” Finally, it seems that rhetoric will become reality, as a bill is currently being mulled that would aim to punish China (via punitive tariffs and WTO action) for failure to revalue.</div><div> </div><div style="text-align: center;"><img alt="USD RMB Futures - April 2011" class="aligncenter size-full wp-image-2798" height="225" src="http://www.forexblog.org/wp-content/uploads/2010/06/USD-RMB-Futures-April-2011.bmp" width="458" /></div><div>Analysts are not optimistic. “The yuan’s 12-month non-deliverable forwards were at 6.7415 per dollar…reflecting bets for a 1.2 percent strengthening over that timeframe.” That’s down from expectations in April of a 3.5% appreciation. Some still believe that China will revalue in the third quarter, but there is no longer any force behind those predictions. Meanwhile, China continues to make long-term plans for its <a href="http://www.marketwatch.com/story/china-to-lend-out-its-massive-forex-reserves-2010-05-23">foreign exchange reserves</a>, which indicates that it has no intention of unloading it as part of a controlled RMB appreciation. At this point, it’s essentially a game theory problem: <em>when will China budge</em>?</div>

Further Delays in RMB Appreciation

Throughout 2010, I have continuously reported on the apparent inevitability of the Chinese Yuan appreciation. That the currency still rema...

Read more »

Chinese Yuan as Reserve Currency

Even before the sovereign debt crisis in Europe damped confidence in the world’s second most important reserve currency, the Chinese Yuan was on the cusp of being accepted as a global reserve currency.<br /> We’re all familiar with the arguments attacking the Yuan in this context: its currency is pegged, its capital controls are rigid, and its capital markets are shallow and illiquid. Say what you want about the world’s major currencies (volatile, debt-ridden, etc.), but at least none of these factors applies, goes this line of thinking. With the Euro’s future up in the air, however, a potential hole has been created in Central Banks’ respective forex reserves. As replacement(s) for the Euro are sought, such long-held assumptions are being challenged.<br /><a name="more"></a><br /> The Chinese Yuan is attractive for a number of reasons. First, investors and Central Banks want exposure to China’s economy; its average annual growth rate of 10% over the last 30 years is far-and-away the highest in the world. “<a href="http://online.wsj.com/article/SB10001424052748704093204575216680362660888.html?mod=WSJASIA_hpp_MIDDLESecondNews">China’s economic output</a> will be more than $5 trillion, or around 9% of the world’s economy, according to the International Monetary Fund.” Second, the fact that the RMB is fixed is in some ways a perk: the wild fluctuations that most currencies witnessed as a result of the credit crisis has made some wonder if market-determined exchange rates aren’t overrated. Finally, the widespread consensus is that the RMB will appreciate anyway, so holding it seems like a safe bet.<br /> Therefore, “Central banks or sovereign wealth funds from Malaysia, Norway and Singapore have received special quotas from the Chinese government to allow them to gain a bit of exposure to China’s currency. The bet is that holding yuan-denominated assets is an important feature of a diversified national reserve.” In addition, China has signed Yuan-denominated swap agreements with a handful of its most important trade partners, totaling $100 Billion over the last year.<br /> Still, these are small-scale agreements, and Central Banks are really just testing the waters. According to a <a href="http://www.reuters.com/article/idUSSGE64H0I620100518">recent study by the Reserve Bank of India (RBI)</a>, “The Chinese yuan is ‘far from ready’ to gain reserve currency status. Rather, it said China’s yuan was likely first to become a regional currency as trade links with its neighbours expand.” The main issue is not one of stability, but rather of supply. Simply, there are not enough liquid, attractive investments, denominated in RMB. China’s stock and bond markets are filled with unreliable companies, whose primary loyalty is to the State, rather than to investors. Buying Chinese government bonds seems like a safe option, but given, that China finances most of its spending with cash, such bonds are not widely available.<br /> For now, the Chinese Yuan will remain most attractive (from the standpoint of a reserve currency) to regional trade partners, because such countries have a genuine use for RMB. Investors seem to understand this idea, and are using the currencies of such countries to bet indirectly on the RMB. According to one analyst, “On days when trading is especially volatile, the Singapore dollar moves in tandem with the yuan bets. The Malaysian ringgit, Taiwanese dollar and Korean won are also high on the list of currencies affected by the yuan.” In short, the RBI’s assessment of the Yuan seems pretty apt. It will probably be at least a decade before holding the Yuan is as viable (not to say attractive) as the Japanese Yen. For investors who don’t want to wait that long, there are a handful of other regional currencies that they can hold in the interim.<br /> <img alt="The China Effect" class="aligncenter size-full wp-image-2758" height="274" src="http://www.forexblog.org/wp-content/uploads/2010/05/The-China-Effect.gif" width="381" />

Chinese Yuan as Reserve Currency

Even before the sovereign debt crisis in Europe damped confidence in the world’s second most important reserve currency, the Chinese Yuan w...

Read more »

Failed Euro Bailout Would Buoy Yen

Given that only a week has passed since the bailout of Greece was formally unveiled, it’s still too early to determine whether the plan will be success. Regardless of how it ultimately plays out, though, the bailout (not too mention the concomitant crisis) is shaping up to be THE big market mover of 2009. As investors reposition their chips, some early front-runners are emerging. It might surprise you that one such leader is the Japanese Yen.<br /><a name="more"></a><br />On the surface, the Japanese Yen would seem to be an excellent candidate for shorting, especially in the context of the the Greek fiscal crisis. Its fiscal and economic fundamentals are abysmal, and by most measures, it’s debt position is among the least sustainable in the world, behind even Spain, Portugal, and the US. At the same time, the Yen has risen by an unbelievable 8% against the Euro in the last week alone, and many analysts are predicting it will emerge as one of the winners of this episode.<br /> <img alt="Euro Yen" class="aligncenter size-full wp-image-2754" height="288" src="http://www.forexblog.org/wp-content/uploads/2010/05/Euro-Yen.png" width="512" /><br />Why? First of all, with confidence in the Euro flagging, the Yen (and the Dollar) gain luster as the only viable reserve currencies. Regardless of what you think about Japan’s fiscal fundamentals, the longevity at the Yen means that it is inherently safer than the Euro, which may not even exist (in its current form, at least) in a few years time. Second, the current consensus is that the Euro bailout will fail, and as a result, risk tolerance is running low at the moment. With this in mind, it’s no surprise that traders are unwinding their carry trades and that the Yen – “The low-yielding currency of a deflation-prone economy of high savers…entrenched as the <a href="http://online.wsj.com/article/SB10001424052748704250104575238031958724158.html">world’s funding currency</a>” – has rallied.<br /> Analysts have been quick to point out that the rest of Asia (among other regions) are on the other side of this trend. The concern is that the bailout won’t be enough to prevent a repeat credit crunch and that confidence in investments/currencies that are perceived as risky will remain low.<br /> China could be hit especially hard. Since the Chinese Yuan is pegged to the Dollar (and even it wasn’t), it has risen by a whopping 15% against the EUro over the last six months, severely crimping exports to the EU. In addition, “<a href="http://www.nytimes.com/2010/05/18/business/global/18yuan.html?hp">Chinese exporters</a> rely very heavily on bank letters of credit to finance their shipments…When banks have trouble borrowing money themselves — as has been happening as a result of worries about European banks’ possible losses from the region’s sovereign debt crisis — they tend to cut sharply the issuance of letters of credit for trade finance.” It’s no wonder that the Chinese stock market has tanked 21% so far in 2010, and that the Central Bank continues to delay revaluing the RMB.<br /> <img alt="Chinese stocks versus S&P" class="aligncenter size-full wp-image-2755" height="368" src="http://www.forexblog.org/wp-content/uploads/2010/05/Chinese-stocks-versus-SP.jpg" width="190" /><br />Of course, if the plan turns out to be a success, than the opposite will probably obtain. “In this case…the currency of any emerging market or advanced economy exposed to the Asian region’s impressive, China-led economic growth,” will probably rally. “It could be the South Korean won, the Australian dollar, or the currencies of commodity-producing countries like Brazil.” The Japanese Yen, meanwhile, will probably be hit with a dose of reality, followed by a double dose of the carry trade.

Failed Euro Bailout Would Buoy Yen

Given that only a week has passed since the bailout of Greece was formally unveiled, it’s still too early to determine whether the plan wi...

Read more »

China’s Forex Reserves Surge to New Record

<div>There are no words to describe the size of China’s foreign exchange reserves. <em>Massive</em>, <em>Mind-Boggling</em>, and <em>Eye-Popping</em> come to mind, but don’t do the $2.447 Trillion justice. What’s more, this figure represents the end of March; the current total has almost certainly surpassed $2.5 Trillion.<a name="more"></a>Interesting, the rate of reserve accumulation has slowed markedly from 2009. In the first quarter of 2010, the reserves grew by “only” $45 Billion, compared to growth of $125 Billion in the fourth quarter of 2009. There are a couple key explanations for this slowing. First, China’s trade balance has narrowed considerably over the last twelve months, to the point that it in March, it recorded its first trade deficit in six years. Second, China <a href="http://www.safe.gov.cn/model_safe/news/pic/20100419102502649.xls">tallies</a> its reserve growth on a net basis – after accounting for changes in valuation. Given that the majority of China’s reserves are still denominated in US Dollars, then, the Dollar’s appreciation over the last quarter may have shaved $40 Billion from the accumulation of new reserves. With this in fact in mind, the actual slowdown is probably much less pronounced than the numbers would suggest.</div><div><img alt="Breakdown of China's forex reserve buildup 2003 -2009" class="aligncenter size-full wp-image-2692" height="369" src="http://www.forexblog.org/wp-content/uploads/2010/05/Breakdown-of-Chinas-forex-reserve-buildup-2003-2009.jpg" width="553" /><br />Besides, exports and foreign direct investment both continue to grow at healthy clips, which means there is nothing (barring a revaluation of the RMB) which could significantly slow reserve accumulation going forward. Even with a revaluation (that many experts believe is imminent), the need to further accumulate reserves will not be impacted, because the RMB will certainly continue to be pegged to the US Dollar. In order to prevent price inflation (which is already creeping up) from reaching dangerously high levels, then, the government will have no choice but to continue to soak up all capital inflows for as long as the RMB remains pegged.</div><div>Speaking of revaluation, the unchecked growth of China’s forex reserves would seem to strengthen the case for it. As the <a href="http://blogs.wsj.com/chinarealtime/2010/04/20/bigger-and-more-volatile-explaining-china%E2%80%99s-forex-reserve-buildup/?mod=rss_WSJBlog">WSJ analysis</a> showed, the value of China’s portfolio of reserves has fluctuated wildly over the last five years due both to gyrations on the capital markets and volatility in forex markets. In fact, China has lost a massive $70 Billion due to such volatility since 2003. In short, this program of accumulating reserves is not only a massive headache, but also a losing proposition. Experts estimate that more than 2/3 is still denominated in USD. Since the Chinese RMB is also pegged to the Dollar, that means that as the RMB appreciates against the Dollar, the value of its reserves will fall in local currency terms. Rectifying this problem is basically impossible, as the <a href="http://www.nytimes.com/2010/04/30/business/30yuan.html?src=busln">EU sovereign debt crisis</a> has demonstrated. It has looked into the possibility of investing in alternative assets such as <a href="http://www.marketwatch.com/story/china-not-too-keen-on-gold-says-forex-chief-2010-03-09">Gold</a>, Oil, and other commodities but there is simply not enough global supply to soak up more than a small fraction of China’s $2.5 Trillion. For all of the problems with the Dollar, the alternatives are just as bad, if not worse. At this point, the best China can hope for is to “cut its losses” by revaluing sooner rather than later.</div>

China’s Forex Reserves Surge to New Record

There are no words to describe the size of China’s foreign exchange reserves. Massive , Mind-Boggling , and Eye-Popping come to mind, but d...

Read more »