Currency Revaluation

[Green Pea]

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.

That's right. If they are propping up the dollar then they do need more liquidity. They are not fund managers. Let's hope they aren't like Bank Negara, either.

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.

Yes, they could if they wanted. Maytaq and IBM are marginal businesses at best. They failed in the Unocal bid. Again, what else is out there?

So, until they figure out how to buy companies or make other long-term investments, then 4% (or even 1% short-dated paper) is the way to go. There's no shame in it. It's risk-averse, prudent, and liquid. I don't think it's a "perverse" or "strange" policy.

[trevelyan]

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.

Green Pea -- you're making a mistake here.

Chinese purchases of American treasury bonds prop up the value of the USD by reducing the supply of dollars internationally. That is the distortion. It is also an effect that reverses itself precisely the moment bond holders cash out. So it is false to claim that the investment does not distort prices. The implication that 4% is the real rate of return on Chinese investments in treasury bonds is also false.

At some point in time, the Chinese will either use their USD to purchase American assets (stocks, bonds, land) or try to sell the currency on international markets. This will result in inflationary pressures if the dollars are spent within the United States, or depreciation if they are spent internationally. The Federal Reserve can try to neutralize the inflow of USD, but they would need to hike interest rates significantly to do so, and any significant hike would likely have a much greater negative effect on the American economy than accepting limited inflation/depreciation.

Real Rate Return = Nominal Rate of Return - (Inflation Rate + Rate of Depreciation)

Most of the economists I've read on this question assume that the USD is going to devalue by ten or twenty percent over the next few years. Even if we make a very conservative guess of 2% depreciation per year and assume that there is NO INFLATION in the United States, this is going to halve the profit earned by Chinese investors. A more realistic scenario would have USD inflation and depreciation combine to equal more than 4% and the rate of return on treasury bond purchases go negative. Remember that the trade off for foreign investors is not between investing in either the US stock market OR the US public debt as is implied above. The alternate investment for the Chinese central bank involves holding public debt in other, more stable, currencies such as the Euro.

Given realistic estimates of the extent to which the US dollar is overvalued, the growing US trade deficit and the enormous government deficit, for the Chinese to invest in American treasury bonds at current rates constitutes an economically irrational act. The real question is whether this is good news for the global economy by stabilizing currency values and leading to slow but steady readjustment, or if it is exacerbating the inevitable shock of adjustment and fueling a global financial crisis.

[Green Pea]

You guys seem to think there are all these investments out there for China, but I've heard no alternatives except Maytag, IBM, Unocal, and the more "stable" Euro. Maytag and Unocal never went through. After IBM, that leaves $248.25 billion to move.

Name the investment. What does China buy? What alternate investments? What do they buy today? Not some time in the future in the land of theorising economists, but today. $248.25 billion.

[gato]

Let's say that the Chinese government wants to continue to prop up the value of the dollar and therefore wants to keep the money in US dollar-denominated assets, it can take an indexing approach with its investment and buy up a share of the entire US stock market. It's what the Vanguard Total Stock Market Index Fund (annualized return of 10% since 1992) tries to do:

http://flagship3.vanguard.com/VGApp/hnw/FundsPerformance?FundId=0085&FundIntExt=INT&DisplayBarChart=false

See also the Wilshire 5000 index, which tracks about 7000 public US companies. http://www.investopedia.com/university/indexes/index5.asp

[trevelyan]

Central Banks do not invest in stock markets.

The alternate investment is for the Chinese Treasury to hold a broader portfolio of debt that includes bond issues from other countries, and particularly those expected to appreciate against the dollar. This will push foreign interest rates down and American interest rates up and help shift the international economy back into equilibrium.

The problem has nothing to do with the efficiency of stock markets versus bond markets as investment targets. The problem is that the coming depreciation of the USD threatens to wipe out any gains foreigners might make from investing in the currency. Interest rates just aren't high enough to justify investing in a currency which is likely to depreciate by 10%. Canned fruit would be a better investment.

Even if one could not find any willing borrowers (unlikely), converting a portion of USD holdings to other currencies on international capital markets would not be difficult given the liquidity and volume of the market. And simply holding reserve currency in non-USD would be more rational than investing at a loss.

[Green Pea]

Central Banks do not invest in stock markets.

Precisely. They will not put money in stock markets or a Vanguard fund (which has a 5-year return of -1.7%). They operate by different rules with different objectives. They are not seeking above-average returns because they don't need to.

In China's case, they can put money into t-bills or bonds with little trouble and get the cash back with a 3-4% virtually risk-free. They are buying security, liquidity, and the ability to execute. They might still do that even if they got a -1% real loss. That's not necessarily irrational or perverse.

They don't need to diversify out of dollars. Will the dollar depreciate? Maybe it will, or maybe it will appreciate. No one really knows. Currency moves won't make much of a difference anyway because the Chinese real economy (non-USD company profits) will compensate for it.

[trevelyan]

They don't need to diversify out of dollars. Will the dollar depreciate? Maybe it will, or maybe it will appreciate. No one really knows.

Respectfully, I don't think you're following the economic news if you think that there is ambiguity about the direction of pressure on the dollar. The United States has been running sustained and massive trade and budget deficits for years. Even the IMF is now estimating that 15% depreciation would result from a "benign market-led adjustment".

They are buying security, liquidity, and the ability to execute. They might still do that even if they got a -1% real loss. That's not necessarily irrational or perverse.

This offers no advantage over holding cash, and it is strange to claim that the United States is the only country whose debt issues offer "security, liquidity, and the ability to execute".

I don't think anyone here is claiming that China has no motives for continuing to prop up the dollar. Precipitating a dollar crisis would threaten their political relationship with the American government and access to their largest export market. So if one accepts a loose definition of "rationality" its fine to claim that Chinese investment policy is rational.

But this isn't the same as claiming that their investments are being made to maximize returns or at least minimize losses, or that there are no better investments. When the dollar finally does depreciate, an equivalent portion of the Chinese government's USD-denominated assets will vanish.

Anyway, perhaps I've misunderstood the intention behind people's posts, but that's the difference I read as being in contention earlier in this discussion, and I don't think it really needs to be, if that was really what was at stake.

Cheers.

[gato]

I read that China and many of its Asian neighbors are all planning to move gingerly towards the Euro. Korea, Malysia, and a few others might be more "rational" and could beat China to the punch.

I see the Chinese government's huge US-dollar holdings as mainly a way to control the exchange rate and not as an investment. And if you've taken college economic courses, you know that manipulating the exchange rate is hardly the most efficient way to promote economic growth.

As for potential investments, China has plenty of domestic public investment needs. Isn't it odd that the government is seeking foreign capital to extend the Beijing subway system? Not surprisingly, there hasn't been many takers. There's also the huge need to greater investment in public education. Currently, China only spends about 3% of its GDP on education. Comparable developing nations average about 4%. The US spends 7%.

[Green Pea]

Respectfully, I don't think you're following the economic news if you think that there is ambiguity about the direction of pressure on the dollar. The United States has been running sustained and massive trade and budget deficits for years. Even the IMF is now estimating that 15% depreciation would result from a "benign market-led adjustment".

Of course there is amibiguity in the direction of the dollar. Just because the IMF or economists predict market moves, doesn't mean it will happen. It's not so easy to say the dollar will depreciate either. It won't move in a straight line, eg it could appreciate 30% first before it crashes. It might go down versus the euro, sterling, and franc, but it could crush the yen, yuan, rand, baht, and peso at the same time.

As for potential investments, China has plenty of domestic public investment needs. Isn't it odd that the government is seeking foreign capital to extend the Beijing subway system? Not surprisingly, there hasn't been many takers. There's also the huge need to greater investment in public education. Currently, China only spends about 3% of its GDP on education. Comparable developing nations average about 4%. The US spends 7%.

That's an excellent question, gato. The Chinese economy is geared to build stuff. My view is that China doesn't really need any more large-scale infrastructure projects. There are plenty of roads, bridges, buildings, dams, and factories. Problem is no one knows how to drive properly on the new highways, or prevent new buildings from decaying rapidly. This creates usage inefficiencies. Yet, they keep building with dimishing marginal returns on investment. No wonder foreign investors are not so keen to sign up anymore. If this is the case, then I think the economy is headed down fast. Who's going to finance over-capacity?

[bhchao]

Beijing is giving two key US senators a warm reception in the wake of a pending bill in Washington that would impose a 27.5% tariff on Chinese exports to the US unless Beijing substantially revaluates the yuan.

http://www.nytimes.com/2006/03/23/business/worldbusiness/23china.html?_r=1&oref=slogin

"Global Times, a tabloid newspaper in China's capital, usually offers its readers a rich diet of nationalist propaganda on subjects like Japanese war crimes and American hegemony.

So it is telling that it devoted its front page on Tuesday to respectful, even admiring, coverage of the China visit of two United States senators, Charles E. Schumer of New York and Lindsey Graham of South Carolina, who have attacked Beijing for "illegal currency manipulation," "mercantilism" and "failure to play by the rules."....

With a banquet in the Great Hall of the People, a roster of top-level meetings and fawning attention in the state-run press, China wants to win over Mr. Schumer and Mr. Graham.

The reason seems clear: At a time of rising economic nationalism in the United States, highlighted by the rejection of the Dubai ports deal, the Beijing leadership fears that a bill drafted by the senators to impose a 27.5 percent tariff on Chinese exports to the United States has a chance to become law. That would upend economic relations between the world's richest nation and its fastest-growing rival.

The bill would impose the tariffs unless Beijing substantially revalued its currency, the yuan, which critics say the government keeps artificially low. It has met firm opposition from some business leaders and economists, who say they fear a trade war, but it garnered 67 votes in a nonbinding tally in the Senate recently and may come up for a formal vote as soon as March 31....

Beijing has controlled its currency within a narrow band around 8 yuan to the dollar, a level that critics say gives it an artificial trade advantage. Despite American pressure, China has allowed its currency to appreciate just 3 percent since it broke a formal, fixed peg to the dollar last July.

China is defending itself against the onslaught, but gingerly. Prime Minister Wen Jiabao, meeting a group of foreign business leaders this week, urged them to convey the message that "it is unfair for the U.S. to scapegoat China for its own structural problems," according to people who attended the meeting.

But Mr. Wen and other top leaders are also trying to improve the atmosphere before President Hu Jintao's first official visit to the United States, scheduled for mid-April. They have promised to tighten enforcement of intellectual property rights and to move steadily toward a more market-driven exchange rate for the yuan, also called the renminbi...

The general sentiment in Beijing is that the threat of the Schumer-Graham tariff can still be headed off. A high tariff would result in "unaccountable losses" to the American economy, because consumers and businesses depend on cheap Chinese imports, said Liu Baocheng, of the Sino-U.S. School of International Management at the University of International Business and Economics in Beijing.

But after the collapse of the Dubai deal, which Mr. Schumer helped bring about, and the failure last summer of a major Chinese energy company's bid to take over the American oil company Unocal, China has grown fearful of surging economic nationalism in the United States...."

[adrianlondon]

For someone like me, who is planning on spending the second half of this year studying in China, this is important news. Normally, I'd use any impending change to grab the foreign currency in advance, but one can't do that with RMB. I'm stuck with whatever exchange rate happens to be in use at the time I hit the ATMs in Beijing.

[roddy]

UK Banks and maybe travel agents / the post office will order RMB for you - or at least they did for me before I made my first trip here, nervously clutching my Lonely Planet and shaking at the knees . . .

Exchange rate might not be great and you might need to wait a while, but it might still work out worthwhile.

Roddy

[adrianlondon]

Oh, right; I thought one couldn't get RMB outside of China. I'll have a look and see what sort of exchange rates I get offered.

[Ferno]

maybe a bit off topic, but I never understood the whole currency thing

in terms of domestic buying power, currency doesn't give you a lot of info because cost of goods and wage amounts vary in different countries. ie, the Euro is stronger than the USD but then again everything is more expensive in Europe in comparison to wages... and a European can't come to the US and use his Euros to increase his buying power, because the amount of Euros he earns is smaller.

and in terms of international trading, isn't everything constant? ie, if a country has a low-valued currency, they sell their products for larger amount of that currency - if a country has a high-valued currency, they sell their products for a smaller amount of that currency.

[adrianlondon]

Not quite.

Let's say you're paid £20,000 a year for your job in the UK. After tax etc etc let's make up the fact you have £5000 to spend.

If you buy good from abroad or travel abroad, that £5000 is converted into the local currency. Let's say £1 = 15RMB. SO you have 75,000RMB to spend. Whee!

Then, the Chinese government gives in to American pressure and revalues the currency so that there are only 10RMB to the pount. You now only have 50,000RMB to spend on Chinese goods.

[Ferno]

And domestic prices of Chinese goods wouldn't change at all in response?

[adrianlondon]

Not much. How can it? A chinese person's salary hasn't changed, therefore how can the price of everything he/she buys?

[chenpv]

Sorry if I pull it a little further off topic. What is the use of exchange rate anyway? I mean if someone in UK could buy 5 TV sets by his 5000 pounds and someone in China could also buy 5 TV sets by his 5000 RMB, IMHO, they have the same consuming capability....... And here comes the perplexing exchange rate...... Whats it for?

[bhchao]

Look like China was able to woo over the two US senators. There is no guarantee though that Beijing will allow the currency to float more freely.

http://www.nytimes.com/2006/03/29/business/worldbusiness/29trade.html?_r=1&adxnnl=1&oref=login&adxnnlx=1143669600-sk2NSnNE3ONv+CdLdkCRwg

Two of China's most relentless critics in Congress announced a temporary cease-fire on Tuesday in their long-running attack on China's foreign-exchange practices.

In an about-face, Senator Charles E. Schumer, Democrat of New York, and Senator Lindsey Graham, Republican of South Carolina, dropped plans for a bill that would threaten steep tariffs on Chinese imports if Chinese leaders refuse to let their currency, the yuan, rise in value against the dollar.

Both lawmakers said they had become more optimistic as a result of their weeklong trip to China, where Chinese leaders emphasized their willingness to let their currency float more freely and to address other aspects of their nation's growing trade deficit with the United States.

"We learned that the Chinese have come to a conclusion that a fixed currency is no good for China," Mr. Schumer said Tuesday. "We believe that the progress we have seen in the last two or three weeks will continue."

Mr. Schumer and Mr. Graham said they would not demand a Senate vote on their bill, which would threaten China with a 27.5 percent tariff on all exports to the United States if it did not let its currency move in line with market forces....

[bhchao]

China has allowed its currency to appreciate beyond the 8 yuan mark. Exporters are worried that the appreciation will reduce their competitiveness by reducing their profit margins.

An appreciation of the yuan, or allowing it to appreciate based on market conditions could reduce China's reliance on an export-oriented economy, and allow it to make the transition into one catered to domestic consumption; with an emphasis on higher quality, technologically advanced products that consumers would buy.

This could also encourage production/operations efficiency by cutting costs to produce higher profit margins.

http://www.nytimes.com/2006/05/16/business/worldbusiness/16yuan.html?_r=1&oref=login

China allowed its currency to strengthen past the symbolic level of eight to the dollar Monday, rattling Asian markets already shaken by the dollar's extended slide and Friday's drop in share prices in the United States.

The actual rise in the Chinese currency was tiny: one-tenth of a percent from Friday's level. But the breaching of that threshold unnerved regional investors, who feared that it could open a path for broader declines in the dollar...