Updated Thoughts On The Yuan

by: Ben Kramer-Miller

Several months ago I wrote an article in which I suggest that investors consider buying the Chinese yuan. Since then we have seen a modest appreciation of about 1.47%.

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In the article I gave three reasons for investors to consider such a position.

  1. Base money supply for dollars is growing faster than base money supply for yuan.
  2. There is a massive credit bubble in China, which implies that there will be deflation in China's future that will make yuan holdings and the highest quality yuan-denominated debt instruments increase in value should this bubble burst.
  3. Demand for the yuan outside of China is growing.

Recently I suggested that there might be a fourth reason--China may back its currency with gold.

In this article I want to briefly provide an update to these points. Simply put, all of these reasons for owning some yuan either through an ETF (CYB, CNY, FXCH) or preferably more directly through a Chinese bank account are in tact. In fact they are more acute than they were back in May when I first address them.

Base Money in China vs. the U. S.

Base money in China has been essentially flat in China. In May it stood at 5,560 billion yuan. In December the figure stood at 5,640 billion yuan--a 1.44% increase.

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Needless to say the money supply in the U. S. has been soaring, thanks to the quantitative easing program instituted by the Fed. In May the monetary base stood at $3,136.4 billion, whereas in December it was $3,736.8 billion, which is a 19.1% increase.

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A Credit Bubble In China

In my first article I illustrated the credit bubble in China by showing the reader what happened to the money multiplier--M2 money supply divided by the monetary base--when it reached 9 in the U. S.--it collapsed. The money multiplier measures the frothiness of the economy, or how much debt is out there relative to "money." In China in May this figure reached a shocking 18-times, meaning that credit-creation accounted for almost 95% of the claims on yuan in China. Given that China's economy is smaller and more localized than the U.S.'s it stands to reason that data points such as the money multiplier can get further out of whack, although 18-times seemed sufficiently large enough to engender concern.

Since then we have seen a minor increase in the M2 money supply in China, which sits at 107.93 trillion, which means that the multiplier has risen to 19.1-times. In short the credit bubble in China is slightly larger than it was, although it is that much closer to bursting.

Demand for the Yuan Outside of China

While quantitatively very little has changed on this front, we recently saw a major development Sunday morning (Jan. 12)--China launched a 2.5 yuan-bond in London. While this amounts to just a few hundred million dollars, the ramifications are significant insofar as China is going to directly access the western capital markets. This goes beyond what I emphasized in the first article, namely that China is making trade deals with individual nations to use the yuan rather than the dollar in bilateral trade. It goes beyond this because it is an international move that touches the entire West, not just London. Furthermore the significance of the Chinese choosing London--perhaps the most important center for international banking and finance--cannot go unmentioned. Access to the Chinese capital markets is a definite future event that will go beyond a handful of esoteric banks peppered throughout the West, or a few illiquid ETFs that have generally done a poor job of tracking the exchange value of the yuan.

Conclusion

While the yuan has appreciated somewhat since May the case for arguing it is decidedly stronger on all fronts. Therefore investors should consider taking the advice I offer in my the first article on the subject and open up a yuan bank account. Investors can easily do this through the Bank of China's website, or more specifically through its online banking website. Those investors who live in New York, Los Angeles, or Chicago can visit local branches.

Those investors who want to be able to trade still only have access to the highly illiquid ETF market that does a poor job of tracking the exchange value of the yuan. But bear in mind that trading shouldn't be the goal. The bet I have in mind, in fact rests largely upon the fact that trading in the yuan will be as easy as trading the euro or the yen, and by the time this happens i suspect that the trade will largely be over.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.