The Most Undervalued Currency in the World
by
Bryan Rich
When
the leaders from the 20 most powerful countries in the
world (including China) met last month, they left with a
pledge to work toward rebalancing global economies.
That
means countries running large trade deficits, like the
U.S., would save more, consume less, and produce more ...
and export-driven economies, like China, would spend more
and export less.
That's a lofty goal. Even lip service to some. To me, it's
a statement that speaks directly to China. It's "code"
that China needs to stop manipulating its currency.
Lopsided trade was a key driver in the asset price bubbles
over the past few years and the continuation of these
imbalances are a recipe for another rendevous with global
recession.
That's why the G-20, the IMF, the OECD — all of the major
institutions and central banks of the world — are talking
about the importance of repairing imbalances.
And,
again, it all boils down to China ...
China's Currency Policy
Gives it a Distinct Advantage
While most of China's major economic competitors around
the world have seen their currencies climb against the
dollar by 20 percent, 30 percent, 40 percent ... even 50
percent in the last eight months ... the Chinese yuan has
been virtually unchanged.
That's because China controls the value of its currency.
And that creates a major advantage for Beijing in the
competition for world exports. It's a primary reason China
has been able to achieve such a rapid rise in global
economic power.
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While other world currencies have climbed against
the dollar, the Chinese yuan has been virtually
unchanged. |
China's currency policies have long been a problem for the
United States. Cheap Chinese goods and cheap credit fueled
a consumption binge for U.S. consumers and a massive trade
deficit.
Prior to the financial crisis, the U.S. was on its own to
convince China to adopt a more "flexible currency regime"
... i.e. stop keeping its currency artificially weak.
The
results were modestly successful — only after the U.S.
Congress threatened to impose a tariff on Chinese imports!
China allowed its currency to appreciate by 17 percent
against the dollar between 2005 and 2008.
But
since the financial crisis, China has returned to a peg
against the greenback. Its authority to determine the
value of its own currency and to stockpile U.S. dollars
through one-way trade has put China in a position of
strength against the rest of the world.
That's why when the rest of the world was in recession,
China was still churning out growth and is now
outperforming in the early global economic recovery phase.
Look, it's no secret that China has the most undervalued
currency in the world. In fact, the Chinese yuan would
have to appreciate more than 40 percent against the U.S.
dollar to bring the exchange rate in line with economic
fundamentals.
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While the rest of the world was in recession,
China continued to grow. |
To
make matters worse, a weakening dollar and recovering
global appetite for risk has sent world currencies soaring
over the past eight months. But Chinese currency has been
weakening along with the dollar, an effective
devaluation against its Asian trading competitors.
Because of this currency advantage, China has been winning
even more share of the world export market.
And
countries that need healthy exports to work their way out
of recession are losing out. That's why over the course of
the last few weeks we've seen South Korea, Taiwan, the
Philippines, Thailand, Indonesia and Hong Kong all
intervene to weaken their currencies.
Meanwhile, Major Developed Economies
Are Losing Out, Too. So ...
The
China currency issue will likely become a major global
point of contention.
Remember, to put the world back on a sustainable path to
growth, the G-20 pledged to ...
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Work toward repairing global trade imbalances,
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Avoid protectionism,
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And avoid competitive currency devaluations.
All
three of these key issues have a lot to do with China's
currency policies.
In
an indirect way, the world is telling China to stop
manipulating its currency and to work on creating a more
balanced economy by cultivating domestic demand.
If
China continues to manufacture a weak currency, dump cheap
products on the rest of the world, and stockpile currency
reserves, points number 2 and 3 will grow in scale and
frequency.
That's a major threat for the global economy.
For
now, traders are beginning to make bets that China will
placate the rest of the world with some
appreciation in its currency. But not much.
The
chart below shows the U.S. dollar vs. the Chinese yuan.
The red line shows a Beijing-manipulated exchange rate
while the blue line indicates the market's expectations
for where the exchange rate will be in twelve months:
Source: Bloomberg
The fundamental equilibrium exchange rate suggests the
yuan is 40 percent undervalued.
As
you can see with the red line, China started allowing its
currency to appreciate in 2005, at the rate of about 6
percent a year. But in 2008 that gradual strengthening of
the yuan came to an abrupt halt.
Now
the market expects the yuan to start trading higher again
from the dynamics I mentioned above, but only 2 percent by
this time next year.
This
won't be nearly enough to keep its counterparts at bay.
I'm
looking for this discussion on China's currency to heat
up. And the potential political fallout could cause quite
a stir for the global economy and currencies.
Regards,
Bryan |
