As Long As China's Excess Money Supply Remains, Keep Buying

Our view on what Beijing wants to do about its $1.3 trillion in reserves.

1. Reserve Update
In Sunday's press we read that China's foreign exchange reserves topped US$1.33 trillion at the end of this June. This makes them the world's largest. They grew by 41% when comparing the first half of this year with the first half of last year.

They grew because of the rising trade surplus and strong foreign direct investment inflows.

The results:

• the yuan rose yet again, reaching 7.5845 against the dollar, and
• M2 money supply rose by an annual 17.1% in June - above the Central Bank target of 16%

2. Measures to counter reserve frenzy
• Interest rates. The Central Bank has been increasing these again. Already this year, it has raised borrowing costs twice, and the reserve requirements of commercial banks four times;
• State investment company. Beijing wants this company to invest $200 bilion to get better returns and to stem losses from its investments in US$ Treasury bills. The 5% that Beijing earns on its treasury holdings is canceled by the dollar's 5% decline against the RMB;
• Overseas direct investment. Beijing wants companies to increase their overseas investments by $66 bn by 2010, and by $30 billion annually until 2020. They already have invested $16.1 billion overseas, so they have another $50 billion to go in order to reach the 2010 target of $66 billion, and
• Cut export tax rebates. On 1st July, the government reduced or canceled a variety of export tax rebates, making it less profitable to export. These cuts, in conjunction with rising labor costs and stronger pollution controls, may alleviate some of the export frenzy.

I personally think that these measures will remain ineffectual. This implies that upward pressure remains on the RMB.

How to Make Money Off This Idea
As long as China's excess supply of money remains, keep buying the market.

• Go into A shares using the FT/Xinhua A share ETF, and
• Go into the H share market by buying the Hong Kong-listed H share tracker
• Or just buy large cap H shares: these are the ones chased by institutions.

Comments

[huangthomas]

The negative impact of new policy on Chinese stock market outweight benefit of RMB appreciation (please see my comments on June 25, 2007). The new policies lead to drop (-7.5%) in Shanghai Stock Index. I would short A-shares. The H-share market in Hong Kong tell an entirely different story. Because of potential influx of Chinese capital into Hong Kong and elsewhere, the Hang Seng Chinese Enterprise Index (of H-shares and Red Chip-shares) have jumped 39% in a month. Unlike RMB, Hong Kong currency is pegged to US$. I would go long on H-shares, Red Chip-shares, and ADRs.

[Intelledgement]

Dr. Enzio von Pfeil: I agree with your thesis, but would add that continued growth of China's foreign reserves is not the sole indicator one should attend to. If the USA consumer significantly downshifts anytime soon, that would be a signal to get out of Chinese stocks, or even go short. Also if the US$ suddenly drops in value, even if the number of US$ China holds continues to increase, if the constant value of the Forex held by China delines signficantly, that would be another bad sign.