China to Allow More 'Flexibility' to Its Exchange Rate

Includes: CNY, CYB, FXE, UDN, UUP
by: Ray

The media is abuzz with China’s central banks decision to allow the RMB to float a bit more freely, but no one is asking the more important question, which way will they let the currency float? Everyone and by everyone I mean certain U.S. Senators and some White House officials, claims that the artificially weak currency has cost Americans their jobs. The claim is it has cost millions of Americans jobs, but this is utter nonsense and political posturing.

A weak currency definitely gives China an advantage, it gives any country an advantage, but at the end of the day China had their currency pegged to the U.S. dollar, so perhaps our political officials should have been looking in the mirror while throwing criticism towards China. In other words, if our currency was stronger it stands to reason that China’s currency would be stronger as well. However, we all know that the intention of the U.S. government is not to have a strong dollar, but to have a weak dollar. That would mean a weaker RMB which would give China an advantage, in the eyes of those living in the land of the blind, in world trade.

How do we know the U.S. wants a weak dollar? Simple, Obama told us. He wants to double exports within 5 years, but we have the most expensive workforce in the world and are largely viewed as inefficient because of our pesky workers' rights laws. That makes producing goods in the U.S. for export very difficult with the exception of complicated financial instruments, bombs, military hardware and some technology items. Let’s look at producing hammers: A hammer made in the U.S. would cost about $10, but a hammer made in China would cost about $5, why? Labor costs. The steel is going to be about the same and they are shipping the steel to China and the final product from China to the U.S. at half the cost. They pay the same amount of money for transportation, energy and raw materials, but they pay less for labor. My point is that we cannot export more without severely devaluing our currency or our standard of living.

Which brings me to my next point, China’s willingness to let their currency float more freely. Great, but which way? One of China’s major manufacturers, the one were all the people are killing themselves, you know, Apple's (NASDAQ:AAPL) plant, is raising their workers’ salaries by 14%. Now, forget that 14% on $2 an hour only means another $.28 an hour, but that is a significant increase in labor costs. So are your iPad and iPhone costs going up? No, as an aside, this is just one more reason that I feel good about not owning an Apple product.

I have also said that the euro’s collapse is a significant issue for China. It still is, and a further decline in the euro means China’s #1 importer of goods will import less, much less from the big red giant. What I am saying is it is entirely likely that China will float their currency lower and now they can claim it is the free market doing it. Smooth move if you ask me.

It is not possible for China to have a rising currency, a weakening euro, a weakening USD and higher wages for its workers with most manufacturers maintaining profit margins of 3%. It just doesn’t work for China. We all know the ruling party wants to maintain its power and in order to do that it must make the people happy. Without plus 8% GDP growth, unemployment will increase and discontent will grow, threatening the powers that be. In other words, the RMB will go lower unless other currencies increase in value. I realize this is an outside the norm view, but if one steps back and looks at the bigger picture it makes sense.

I could be wrong and perhaps every firm is out there hedging their currency, but that is highly doubtful. Even if they did, it would not stop the slowdown in exports and all the bubbles in China will pop at roughly the same time, within the next few months. It is funny that the same people who said the U.S. was not in a real estate bubble in 2006 are saying China is not in bubble territory now. They are.

Any slowdown, even a minor hiccup is extremely dangerous and has worldwide ramifications. We are talking about the engine of the “worldwide recovery story” here, not some small corner of the world that does not matter. If their currency appreciates and the slowdown is bigger than anticipated, (and they always are I might add), there are no more surpluses, no more U.S. debt auctions to show up at and prices will head higher on products.

It also means that they may become net sellers of Treasuries instead of buyers, which is not good news, if their currency does appreciate. However, it won’t happen, it will go lower and everyone will be surprised when it happens, except for me. It is clear as day that the Chinese economy is showing extreme signs of stress, look at their markets, they are way off their highs and have been for some time now.

From my lens the entire system is in major trouble and it is evident when we try to find scapegoats for our problems, bankers, the Chinese with their cheap currency, etc. The system needs to reset itself and it cannot happen with all of this intervention and additional debt. Everything needs to be restructured and debts need to be purged from the system, but this will never happen as it means everything goes to zero. Instead we will carry on blaming others, inflating our way out and causing much more pain than by having an absolute reset.