Seeking Alpha

Sober Realist's  Instablog

Sober Realist
Send Message
29 March 2008 On the Road from Samaria When they manipulated the stock market, I remained silent; I was making money and felt superior to the crowd. When they silenced their critics, I remained silent; I was self-righteous and felt they got what they deserved. When they came for the blue... More
  • The Critical Piece to the China Plan: A Managed Currency 7 comments
    Jul 19, 2009 7:24 AM

    The Critical Piece to the China Plan: A Managed Currency

     

    China’s the largest country in the world by population, the third-largest economy and the third-largest exporter. It’s also the owner of over $2 trillion in foreign currency reserves.

    And in the worst global recession since the Great Depression, it’s the only large economy that’s growing! But it’s also the most restricted and least transparent of the bunch.

    So how did China amass such a position in the global economy? And how does one country gather 29 percent of all international reserve assets?

    The common notion is that it all boils down to trade … countries running trade surpluses (net exporters) accumulate wealth from countries running trade deficits (net importers).

    But for China, reserve accumulation and economic growth has as much or more to do with its exchange rate policy as it does with huge trade surpluses …

    You see, exports have been, and are, the key driver of growth in China. And when dollar-based investments and revenues flow into China, converting those inflows to the yuan puts upward pressure on China’s currency. This upward pressure threatens to strengthen the yuan, making it less competitive on a global stage for trade.

     

    China doesn’t want that … China needs a weak yuan to continue exporting its way to growth. That’s why the Chinese central bank manages the value of its currency.

    To offset the local demand to exchange U.S. dollars for yuan, the central bank takes the other side — selling yuan and buying dollars. This keeps the exchange rate stable, and China builds vast amounts of dollar reserves.

    The Weak Currency Advantage …

    For a decade, China maintained a fixed exchange rate policy — the yuan was pegged against the dollar. One U.S. dollar bought 8.27 yuan. This allowed China to undercut the rest of the world, churning out cheap commoditized goods, competing on one thing: Price.

    Consequently, the Chinese economy shot up from $728 billion to $2.3 trillion.

    But in 2005, China changed its currency policy. It abandoned the peg.

    After political tensions rose between China and its key trading partners, namely the U.S., China adopted a “managed float.” Under this policy China agreed to let the yuan trade in a defined daily trading band, while gradually allowing it to appreciate. This was China’s way of pacifying its trading partners while maintaining complete control over its currency.

    Over the next three years the Chinese yuan climbed 17 percent against the dollar, enough to ease a politically sensitive issue, but far less than the relative economic growth would warrant. In fact, China’s economy grew by 43 percent while the U.S. economy grew only 10 percent.

    If China’s currency was determined by market forces, the relative outperformance would:

    • Drive investments into China …

       

    • Drive up the value of the yuan …

       

    • And drive down the value of the U.S. dollar.

    This currency dynamic would slow exports in China and make exports in the U.S. more appealing. A natural balancing mechanism.

    But not only has China been very slow to let the yuan strengthen, thus protecting its export model, it’s virtually put the brakes on currency appreciation altogether since the inception of the global financial crisis.

    The chart below shows the move from a peg, to a managed float, and back to what is effectively a pegged exchange rate …

    http://images.moneyandmarkets.com/1421/us-dollar-vs-chinese-yuan.gif

    China has been moving, however, on another area of its currency policy — the international use of the yuan in trade.

    Until this month, trading of yuan had been heavily restricted by the government — authorized only within mainland China and only through China’s agent banks.

    Therefore, Chinese companies could not settle foreign trade in yuan. Most international trade was priced in U.S. dollars and settled in U.S. dollars, creating the burgeoning foreign currency reserves I mentioned above.

    Now for the first time, China is relaxing restrictions and allowing the yuan to trade offshore with select Asian neighboring countries. This is a first step in China’s attempt to temper growth in its foreign currency reserves and to make the yuan a globally traded currency.

    But the yuan lacks appeal as an international currency. After all, there are hurdles associated with managing currency risk of the yuan, especially because the government controls its value!

    China’s Unfair Advantage …

    As a currency manipulator, China is in violation of WTO rules. Yet its trade partners have been hesitant to levy that charge. Instead, led by the U.S., they they’ve taken a diplomatic approach, encouraging China to move toward a market determined (or free-floating) exchange rate.

    But China doesn’t seem to have any intention on giving up its key mechanism for controlling its competitive advantage on the world stage. Why would they?

    Moreover, China is now  furthering its efforts to create and protect its advantage.

    This time, though, its trading partners are putting up a fight. Both the U.S. and Europe recently filed a complaint with the WTO. They accused China of limiting exports of raw materials to the rest of the world, giving an unfair advantage to its domestic manufacturers.

    And here’s my point: Many perceive China to have the position of strength over the world economy. But with an economy so dependent on a manipulated currency and maintaining unfair trade advantages, resistance from global trading partners could reverse that perception very quickly.

    Remember, it wasn’t too long ago that a couple of U.S. Senators were passing around a bill to hit Chinese goods with a 27.5 percent tariff!

    Regards,

    Bryan

    by Bryan Rich   07-18-09

Back To Sober Realist's Instablog HomePage »

Instablogs are blogs which are instantly set up and networked within the Seeking Alpha community. Instablog posts are not selected, edited or screened by Seeking Alpha editors, in contrast to contributors' articles.

Comments (7)
Track new comments
  • nobby73
    , contributor
    Comments (1177) | Send Message
     
    The desire to keep the Yuan low is all about unemployment. The economy may be growing relative to the rest of the world, but there is huge spare capacity in the urban economy, as in 20% plus unemployment rate. China is committed to a path of industrialization, therefore needs to have the work in the cities for people to do once they have been forced out of farming and the rural economy. If the currency appreciates, exports drop, unemployment rises, inflation rises and wages for those who have jobs will go up, thus creating a dangerous wealth gap between the haves and the have nots. When you look at it from the perspective of social order, which is what they do, the currency levels seem about right.

     

    If the US wants to address the issue, they can just stop buying Chinese products and pay a little bit more for local alternatives, don't blame other people for your over-consumption habits.
    19 Jul 2009, 04:46 PM Reply Like
  • Sober Realist
    , contributor
    Comments (531) | Send Message
     
    Author’s reply » Yikes! The wealth gap will only widen in China. They are between a rock and a hard place.

     

    On Jul 19 04:46 PM nobby73 wrote:

     

    > The desire to keep the Yuan low is all about unemployment. The economy
    > may be growing relative to the rest of the world, but there is huge
    > spare capacity in the urban economy, as in 20% plus unemployment
    > rate. China is committed to a path of industrialization, therefore
    > needs to have the work in the cities for people to do once they have
    > been forced out of farming and the rural economy. If the currency
    > appreciates, exports drop, unemployment rises, inflation rises and
    > wages for those who have jobs will go up, thus creating a dangerous
    > wealth gap between the haves and the have nots. When you look at
    > it from the perspective of social order, which is what they do, the
    > currency levels seem about right.
    >
    > If the US wants to address the issue, they can just stop buying Chinese
    > products and pay a little bit more for local alternatives, don't
    > blame other people for your over-consumption habits.
    19 Jul 2009, 06:51 PM Reply Like
  • Celcius
    , contributor
    Comments (80) | Send Message
     
    The US now has over 16% unemployment and will have the same pressures as China. As this depression deepens the US consumer will not have the means to purchase China's goods. And, the US will want to export its way to prosperity. IMO we will see significantly less trade in the coming years until our global trading partners accept rebalanced trade policies that do not allow one sided surpluses and deficits.
    20 Jul 2009, 12:31 AM Reply Like
  • Sober Realist
    , contributor
    Comments (531) | Send Message
     
    Author’s reply » From the reports I read, China is only inensifying their mercantilist trade policy. They are doubling down. They never listened to warnings from experts years ago not to put all their eggs into the basket of the Asian export model.

     

    On Jul 20 12:31 AM Celcius wrote:

     

    > The US now has over 16% unemployment and will have the same pressures
    > as China. As this depression deepens the US consumer will not have
    > the means to purchase China's goods. And, the US will want to export
    > its way to prosperity. IMO we will see significantly less trade in
    > the coming years until our global trading partners accept rebalanced
    > trade policies that do not allow one sided surpluses and deficits.
    20 Jul 2009, 12:41 AM Reply Like
  • W.Palmer
    , contributor
    Comment (1) | Send Message
     
    Globalisation has made corporations very rich at a huge cost to the western consumer. Now that all the piece good jobs have been exported the tertiary manufacturing of most Western countries has all but disappeared. Western economies have been turned into service economies with only Mc Jobs to offer. Everyone will attest to the declining quality of goods carrying brand names such as HP, Toshiba, DeWalt ,Stanley, G.E etc: with retail prices just marginally less than they would have been were they manufactured domestically, the profits to the distributors are massive. China has always had a quality problem but has offset it by price and to a large extent the brand manufacturers have been complacent because profits are so high.
    If China wants to have a proper economy then it has to generate its own consumers, have fair working practices, a fair legal system, an end to sweatshop labour, and a decent social system and a proper distribution of wealth. This will take many years but what exists now is reminiscent of the cotton mills and mines of 19th century Britain. That will blow up in their faces very soon and then we will see a situation reminiscent of Britain in the 50's ad 60's where there was a total absence of reliability or quality, or a return to hard line communism.
    22 Jul 2009, 04:30 PM Reply Like
  • Sober Realist
    , contributor
    Comments (531) | Send Message
     
    Author’s reply » Very well said W. Palmer

     

    On Jul 22 04:30 PM W.Palmer wrote:

     

    > Globalisation has made corporations very rich at a huge cost to the
    > western consumer. Now that all the piece good jobs have been exported
    > the tertiary manufacturing of most Western countries has all but
    > disappeared. Western economies have been turned into service economies
    > with only Mc Jobs to offer. Everyone will attest to the declining
    > quality of goods carrying brand names such as HP, Toshiba, DeWalt
    > ,Stanley, G.E etc: with retail prices just marginally less than they
    > would have been were they manufactured domestically, the profits
    > to the distributors are massive. China has always had a quality problem
    > but has offset it by price and to a large extent the brand manufacturers
    > have been complacent because profits are so high.
    > If China wants to have a proper economy then it has to generate its
    > own consumers, have fair working practices, a fair legal system,
    > an end to sweatshop labour, and a decent social system and a proper
    > distribution of wealth. This will take many years but what exists
    > now is reminiscent of the cotton mills and mines of 19th century
    > Britain. That will blow up in their faces very soon and then we will
    > see a situation reminiscent of Britain in the 50's ad 60's where
    > there was a total absence of reliability or quality, or a return
    > to hard line communism.
    22 Jul 2009, 08:20 PM Reply Like
  • Michael Clark
    , contributor
    Comments (9084) | Send Message
     
    In Vietnam, Vietnamese laugh at the idea of Vietnamese 'quality'. But they are quick to point out that this laughable Vietnamese 'quality' is much better than Chinese quality.

     

    My wife and I bought 60 pirate DVDs made in China during our 2003 visit to Vietnam. 15 of the 60 actually worked. The Vietnamese laughed and said "You guys did pretty good."

     

    Everything is pirated over here (and in China, I'm sure). If you publish a book in Vietnam, two weeks later the book has been copied and is selling on the street at a discount. Someone else is getting the profit. Music, movies, software -- it's all pirated, cheap, and VERY low quality. But low quality and cheap is better for the Vietnamese -- otherwise they could not afford it.

     

    Some Chinese companies agree to produce Western products in China so they can reproduce the product at diminished price and quality for the Chinese market. Say, they have a contract to produce Crest toothpaste. They might set up a show factory for the production of Western Crest and set up 15 dirty Chinese factories for the production of Chinese Crest. It's a way they can steal the formula and brandname for use in China.

     

    It's the Wild West over here.
    10 Aug 2009, 06:23 AM Reply Like
Full index of posts »
Latest Followers

StockTalks

More »

Latest Comments


Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.