Currency Revaluation

[wushijiao]

Any thoughts about currency revaluation? Some people seem to think it might happen soon.

Here's an Economist article that discussed not only possible Chinese currency revaluation deliberations, but also the semi-xenophobic China bashing by protectionist American politicians. Here's an interesting part:

"If it is hard to tell whether American politicians are just blustering to impress their constituents or really mean it, it is even harder to tell what effect their remarks are having. The markets are abuzz with talk of imminent yuan revaluation, but such hopes have surfaced many times before, and the Chinese government has so far disappointed. Last week the People's Daily, an English-language Chinese paper, reported surprisingly specific plans to revalue the currency, only to quickly retract its story, claiming a translation error. However, some observers wondered if the publication had in fact been used by the Chinese government to test the waters. "

[gato]

I thought China might reevaluate soon, too, until I read Andy Xie's (Morgan Stanley chief economist in HK) comments.

http://www.morganstanley.com/GEFdata/digests/20050506-fri.html#anchor5

Andy Xie (Hong Kong)

I see a very low probability that the Chinese renminbi (Rmb) will revalue soon. China faces major economic uncertainties at home. Its overheated property sector is experiencing uncertain times. A revaluation may cause hot money to leave and, hence, the property market to collapse. On the other hand, elevated expectations of imminent Rmb appreciation could prevent panic selling and help stabilize the property market. The expectation – not the reality – of imminent Rmb revaluation is in China’s interest at present.

Second, when labor shortages emerge, wage inflation could cause a wage-price spiral. China is not experiencing a labor shortage overall. There are pockets of labor shortage. Experienced managers, accounting and legal professionals are examples. Such shortages can be solved over time by increasing supply. The overall picture in the labor market is still one of surplus. I estimate that China has a labor surplus of about 200 million.

Japan’s situation in the 1970s and 1980s was very different from China’s today. Japan solved its labor surplus problem in the late 1950s and early 1960s. Its labor productivity could manifest itself through either wage growth or currency appreciation. China does not have such a luxury. China’s productivity gains actually go to western consumers via lower export prices. A significant appreciation of the currency could trigger another wave of deflation. China today is not comparable to Japan in the 1970s or 1980s.

The political will in Washington seems likely to be for a big appreciation by China, regardless of its language. If China makes a small move, it will only whet Washington’s appetite and invite more demands, in my view. This is why I believe that, if China plans to make a small move, it will need to reach an agreement with Washington that this is acceptable and that there will be no more demands for five years.

This scenario seems unlikely, though. The issue of China’s currency carries political as well as economic implications. I believe that Rmb revaluation is not in the US’s economic interest (see The Wrong Case for Rmb Revaluation, April 29, 2005). However, some voices in Washington are using the currency issue to stir up anti-China sentiment – and these voices are unlikely to fade until China’s economy cools, in my view. This is why I believe that China is better off sticking with the peg for now.

Fourth, the warnings of potential trade sanctions by the US are most likely empty threats. China-made products retail for about four times as much in the US as the US businesses pay Chinese producers. As many as 10 million American workers may be involved in adding value in the China trade, and I estimate that up to 15% of the profits of S&P 500 companies come from marking-up cheap Chinese products. Any sanction on Chinese imports would hurt the US as badly as China, in my view.

[gato]

Keep a watch on Korea, too.

http://www.koreaherald.co.kr/SITE/data/html_dir/2005/05/20/200505200028.asp

The confusion was the second communication incident by the BOK this year. In February, currency markets around the world were alarmed at a report that BOK plans to diversify its more than $200 billion foreign reserves, the fourth-largest in the world.

Traders interpreted the report as the start of dollar dumping by Asian central banks. That sent the dollar into a sharp fall, and BOK officials spent days trying to clarify that it had plans to unload most of its dollars.

The won strengthened more than 17 percent against the dollar since early last year, threatening the price competitiveness of Korean exports, which account for 40 percent of the economy.

Overseas traders believe that Korean foreign exchange authorities are ready to act to contain the won's rise whenever deemed necessary. In contrast, domestic players expect authorities will not intervene heavily.

Market participants expressed grave concerns that the government's continued efforts to curb the won's steep appreciation would only exacerbate the polarization of the economy - the brisk exports coupled with weak consumption. The central bank has spent billions of dollars in the foreign exchange market to prevent the steep rise of the won against the U.S. dollars.

[wtanaka]

It's been said to be imminent for a few years now.

It's all kind of ironic -- China's one of the only countries that is still buying U.S. dollars, which maintains the exchange rate peg, but also is keeping the value of the dollar from dropping even further than it already has.

[englishboy]

The US govenment has something of a dilemma in pushing for a revaluation. On one hand there is a strong lobby looking for restraint of trade in the US, particularly in relation to textiles and for the government not to support them may be difficult. On the other hand, the fact that there appears to be an insatiable demand for US Bonds in China due to Chinese $ surpluses means that the US can keep its interest rates low. This has proved to be a driver to the US property martket.

So the Chinese authorities have no significant economic imperative to revalue. Gato is right in asserting that there is no labour shortage so wage inflation is not a particular issue. Indeed, the speculation on a revaluation may prevent a revaluation happening (the Chinese Authorities have always said that if they were to revalue it would be a surprise to catch speculators on the wrong foot)

So will there be a revaluation? On balance, I think not. But if there is, then no more than 3% as a sop to Washington protectionists

[Outofin]

What do yuant from us?

The Economist is making fun of Americans and Europeans.

To hear American and European officials talk, you might think China was flooding their countries with toxic waste, instead of affordable consumer goods.

[马杰]

I've read numerous articles on how the Yuan peg is costing China dearly in the long run because the peg takes away money needed to pay for more institutional and infrastructure reforms (massive military spending doesn't help either) to buy US debt.

The CCP seems deathly afraid of a big increase in the unemployment picture, though economists predict a floating yuan would give more domestic and international spending power to chinese company and people in the long run, which would eventually offset short term pain.

Likewise, unhitching the RMB would force Americans to save and stop massive housing speculation. The pain would be intense but probably only last a few years as people come to grips with economic reality.

The low cost goods in the EU and the US are artificial and we are only kidding ourselves about how long it can last.

[skylee]

Take a look -> China scraps yuan peg, ties currency to basket

And this -> 中國7月21日起實行浮動匯率制度

[gato]

Wow, so this report from a month ago that the Yuan was right.

http://news.chinatimes.com/Chinatimes/newslist/newslist-content/0%2C3546%2C110501+112005061700009%2C00.html

2005.06.17　 中國時報

胡錦濤下月備禮赴八國峰會 人民幣升5％換軍售

王綽中/台北報導

中共國家主席胡錦濤七月參加在倫敦舉行的八國峰會（Ｇ８）時，將以人民幣升值向西方國家攤牌。來自北京高層消息透露，人民幣升值幅度約為百分之五，胡錦濤將以此為籌碼換取歐盟解除對中共軍售等利益。

與此同時，北京有關匯率改革等措施已全速準備到位，學界緊鑼密鼓撰寫人民幣升值有利中國經濟文章，在內部做好輿論準備，以免引發震盪。

最新一期《亞洲週刊》引述北京的消息稱，面對西方國家逼迫人民幣升值的強大壓力，胡錦濤此次英國之行，有備而去，趁此次會議向西方國家攤牌，以人民幣升值爭取更多的國際利益。

This WSJ report was also right on the money. China apparently is moving towards a Singapore-style "managed float."

http://www.andongkim.com/articles/2005/05/chinacurrencybasket.htm

China Is Considering A Currency Basket As Option for Yuan

By MARY KISSEL, Staff Reporter of THE WALL STREET JOURNAL

http://online.wsj.com/article/0,,SB111659451612839176,00.html?mod=home_whats_news_us

May 23, 2005; Page C1

BEIJING -- Even as China has fended off demands to revamp its currency system, its central bankers have fanned out around the world to solicit advice on the matter. They are paying close attention to Singapore's unusual setup.

Lately, China's central bank has given special attention to how Singapore deals with its currency, the Singaporean dollar, says a banker advising the central bank. Implemented in 1981, Singapore's currency regime is a "managed float" -- a compromise between China's effective peg, set by its government, and the U.S. approach, in which the dollar "floats," its value determined by market forces.

Singapore pegs its dollar to a basket of currencies that mirror the city-state's trading patterns. Its central bank, the Monetary Authority of Singapore, doesn't announce what is in the basket; the authority's bankers just tweak the mix as needed, depending on how Singapore's trade flows change.

The system has worked well for Singapore, which is about three times the size of Washington, D.C., and has a gross domestic product that is roughly half of Wal-Mart Stores Inc.'s annual revenue. From 1981 to the present, income per person in Singapore has risen sharply, inflation has remained contained and interest rates have stayed low, encouraging consumers to spend. Despite essentially open borders for goods and capital -- a chief reason Singapore needed a tool like the basket, since it can't control its own interest rates -- the Monetary Authority of Singapore has managed to keep the Singapore dollar relatively stable while it slowly trends upward.

[skylee]

Wow, those old reports were right.

[gato]

Paul Krugman has some insights on the revaluation. He's an expert on international economics. Yes, why shouldn't the Chinese government spend its billions more usefully than buying up dollars and US treasury bonds? If it wants to subsidize exporters, it could lower the tax rate or do a number of other things.

http://nytimes.com/2005/07/22/opinion/22krugman.html

This uphill flow isn't the result of private-sector decisions; it's the result of official policy. To keep China's currency from rising, the Chinese government has been buying up huge quantities of dollars and investing the proceeds in U.S. bonds.

One way to grasp how weird this policy is would be to think about what a comparable policy would look like in the United States, scaled up to match the size of our economy. It's as if last year the U.S. government invested $1 trillion of taxpayers' money in low-interest Japanese bonds, and this year looks set to invest an additional $1.5 trillion the same way.

Some economists think there is a deep rationale for this seemingly perverse policy. I think it's something the Chinese government stumbled into as it tried to protect itself from the 1997-1998 crisis, and it is reluctant to change because the Chinese economy has been doing well. That is, China's leaders don't want to mess with success.

But pressures against China's dollar purchases are building. By keeping the yuan down, China is feeding a trade surplus that is creating a growing political backlash in America and Europe. And China, which is still a poor country, is devoting a lot of resources to the accumulation of a basically useless pile of dollars instead of to higher living standards.

The question is what happens to us if the Chinese finally decide to stop acting so strangely.

An end to China's dollar-buying spree would lead to a sharp rise in the value of the yuan. It would probably also lead to a sharp fall in the value of the dollar relative to other major currencies, like the yen and the euro, which the Chinese haven't been buying on the same scale. This would help U.S. manufacturers by raising their competitors' costs.

[gato]

The Chinese government might find a better investment than the 4.2% it gets on US treasury bonds. $243.5 billion could buy a dozen Unocals. That could be one of the reasons for the CNOOC bid.

http://www.latimes.com/business/la-fi-markets22jul22,1,5945409.story?coll=la-headlines-business

China held $243.5 billion of U.S. Treasury securities at the end of May, making it the second-largest investor in U.S. bonds, after Japan.

In the bond market, Thursday's trading seemed more directly tied to China's move.

"The thought is that there will be less demand for U.S. Treasury securities," said Sam Stovall, investment strategist at Standard & Poor's in New York.

That fear triggered selling of Treasuries, in turn driving yields higher. The bellwether 10-year T-note yield surged to 4.27%, up from 4.16% on Wednesday and the highest since April 21.

Inflation jitters also hurt bonds Thursday: If prices of Chinese exports increase because of the stronger yuan, the result could be higher U.S. inflation rates, also putting upward pressure on interest rates.

Concern about a possible rise in mortgage rates spurred selling of home builders' shares. KB Home lost $2.40 to $82; Centex slid $3.14 to $76.36.

[shanghaimm]

Best to avoid the same mistakes as the Japanese, ie overpaying for US properties.

[uthmann]

I just received the topic for my thesis at the University of Muenster, Germany: "Analysis of economic effects of the chinese exchange rate policy on the USA and Europe". Can anyone give me some reading advice?

[Green Pea]

The Chinese government might find a better investment than the 4.2% it gets on US treasury bonds.

Really? Where? 4% return on $250b is a good return in my book. It's not so easy to invest that much money without overly distorting prices.

[gato]

CalPERS, the $200-billion California public employee pension fund, earned 16.7% for the 2004 fiscal year and 12.7% for 2005. It uses an assumed annual return of 7.75% for planning purposes. Even that's almost double the 4% return on US treasury.

See http://www.calpers.ca.gov/index.jsp?bc=/investments/home.xml

[Green Pea]

Calpers says it's 5 year return to 7/31/05 is 4.3%.

[gato]

The 5-year number up to 2005 includes the bursting of the internet bubble in 2000-2001 and its aftermath. Look at the annual returns over a ten-year period. It's much better than 4%.

[Green Pea]

You mean the years including the internet bubble? So China should invest in the internet bubble, like Calpers did? Where's the next bubble? Hindsight investing is always so profitable.

Frankly, it's irrelevant anyway because China is not a pension fund. China needs return of capital and liquidity, that's why it buys Treasury's. I'm sure they are happy to sacrifice a few points for that assurance.

[gato]

You mean the years including the internet bubble? So China should invest in the internet bubble, like Calpers did?

Look at pre-bubble 1988-1997. Or any other 10-year period.

China needs return of capital and liquidity, that's why it buys Treasury's.

And a pension fund needs liquidity less than the Chinese government? What do beneficiaries get then?

China is not buying US treasury for their great return, but because buying US dollar-denominated assets allow it to prop up the value of the dollar relative to the yuan. It could choose to buy something other than government bonds if it wants to. It could choose to buy Maytag, for example, or IBM, or Unocal.