I couldn’t help but laugh as I read the first bloggers’ comments about China’s decision to allow the yuan to be unpegged for the first time in two years. A fairly popular writer over at Seeking Alpha actually said that unpegging the yuan would be a nonevent in the short term! Some nonevent!
Monday morning proved that China’s decision was in fact a global event. Stock markets from Tokyo to New York jumped immediately in response to the Chinese decision.
Investment indicators for China itself were even more dramatic. The Shanghai Composite Index jumped 2.9%, its biggest gain in a month. Chinese firms that consume resources from abroad also leapt on hopes that commodities would drop in price as the yuan rose. In New York, the China ADR Index jumped more than 2.5%.
It’s true that the Dow Jones Index eased off after gapping up at the opening. But that doesn’t change the fact that the expected rise in the yuan will be a huge event in the short and the long term.
#1 China Holds the Keys to Confidence
I believe the decision to unpeg the yuan is a major signal that China is confident about its own recovery from the global economic meltdown.
The move also sends a message that China believes its trading partners in the west will soon resume buying Chinese goods. Of course, trade in all of Asia is already on an upswing, driven strongly by Chinese demand.
Previously world markets have shuddered on every hint that Beijing might cut off its massive stimulus program. Defensiveness was the order of the day.
Raising interest rates to cool Chinese inflation was out of the question due to fears that the economic recovery might screech to a halt. During the global meltdown the yuan was pegged to the U.S. dollar for two years in hopes of protecting China’s battered export industries. Now China is showing confidence that its most profitable industries are expanding rapidly enough to take up the slack.
China’s economy will become more efficient and more profitable.
#2 China Will Become a Big Spender
A stronger yuan means that commodities, resources, services and finished goods from all over the world will be more affordable in Chinese markets.
Allowing the yuan to rise will give Chinese companies more buying power. That’s why China Southern Airlines (NYSE:ZNH) and CTRIP.com (NASDAQ:CTRP) were the biggest gainers on the markets. Investors see the price of oil going down in China. That means travel will get cheaper and it will increase with the stronger yuan.
Global mining companies also gained on hopes that China would buy more resources. BHP Billiton (NYSE:BHP) and Rio Tinto (RTP) are major suppliers of ore to China. Both jumped more than 3 percent on world markets.
Australia has been strong during the meltdown because of its raw material sales to China. News of the unpegging drove the Australian dollar to a one-month high.
Stock markets throughout Asia rose at least one percent on hopes for increasing sales to China.
#3 It Won’t be the U.S. Consumers to the Rescue This Time
China’s middle class is quickly becoming a consuming class. The rising yuan will make them richer. Foreign goods will seem cheaper and more attractive.
Companies like Wal-Mart (NYSE:WMT), General Motors (OTC:MTLQQ), KFC and Motorola (MOT) are all looking for gains. They’re hoping that the growing purchasing power of Chinese consumers will mean gains at the cash registers.
Yum Brands (NYSE:YUM) makes 30 percent of its sales in China and has plans to expand its Pizza Hut and KFC franchises. General Motors is one of many international brands looking to sell more parts into China’s booming auto market.
You name the global product. Coca Cola, beer, cell phones or luxury goods, their makers are looking for increasing in sales to Chinese consumers. That’s good news for global brands and great news for the global economy.
#4 Finding A Balance
Nothing irritates the U.S. more than China’s huge surplus in its balance of payments. Many here blame China for America’s crippling foreign debt. Others blame China for stealing U.S. jobs. Here’s a key trend I’ve been watching lately. China’s trade surplus is becoming much, much smaller than it has been in the past. In fact China actually had a brief trade deficit with the world a few months ago.
This trend towards balanced trade with the world can only improve as the Chinese yuan gets stronger. That’s because a more valuable Chinese currency will buy more goods abroad. Countries with weakening currencies will be able to buy less, and that means a better balance. The yuan won’t be allowed to jump by a huge margin in the near future. The Bank of China has made that much very clear. This trend will happen over the long term. And that means a long-term easing of currency strains around the world.
#5 Squelching Inflation
I’ve been seeing a lot of hand-wringing in the financial press about China “overheating”. That’s another way of saying China is growing too quickly. Inflation is becoming a threat to the economy. Personally, I have always believed that the threat was exaggerated. China has the power to move consumer prices down dramatically on domestic goods. Now, a strengthening yuan will impact foreign goods. Imports will become cheaper with every percentage point the yuan moves up in value. That’s another weapon against inflation.
#6 The Political Bonus
China was afraid it would become the whipping boy at the upcoming G-20 meeting in Toronto. The thinking was that western nations would gang up to force China to raise the value of its currency. Bad idea.
Anybody who has been analyzing China as long as I have knows very well that would have created a backlash. Chinese authorities will never allow themselves to be seen as caving in to foreign pressure. Any effort to force China’s hand at the G-20 would have resulted in an ugly fight. And it would have been a fight with no winner. By acting in advance, China gets to set its own agenda. Some western critics will be mollified. Others will not be satisfied. But they’ll have no way of knowing just how quickly China will revalue its currency so they’ll have little to argue about. China simply won’t allow the issue to be raised.
Inside China, I’m hearing that the latest move signals for a victory for moderates who are looking for a peaceful engagement in world politics and the global economy. The losers are the more aggressive Chinese. Some wanted to pursue a path toward global economic and political dominance. That would have resulted in continuing confrontation between China and the west.
The Biggest Nonevent Ever
I hope you can see why this is anything but a nonevent. The stakes are global. China’s decision to unpeg the yuan sets the world economy on a path towards cooperation rather than conflict. I much prefer the route towards global prosperity through cooperation and compromise. So, we have learned, does China.
Disclosure: No positions