Renminbi: Why A Basket Case?

by: Enzio von Pfeil

On 11th December, Beijing announced it would run the RMB against a basket of currencies. Read on for background and investment implications.

Recent history

The RMB was "devalued" by three per cent against the dollar 11th - 14th August 2015. It joined the SDR basket on 30th November. On 11th December 2015, the People's Bank of China (PBoC) announced that she would measure the renminbi (NYSEARCA:RMB) against a basket of currencies.

China's Economic Clock

Readers know that we deem China's Economic Time® to be characterized by an excess demand for money and an excess supply of goods. Not good for the stock market, obviously: little liquidity that can go in to the market and little reason for the turnover portion of profits to improve when there is an excess supply of goods, n'est pas? Besides which, we reckon that China's productivity is low, meaning high unit labour costs, aka slim margins.

RMB support leads to monetary tightening

Courtesy of capital flight, the RMB has been falling. In order to stem this surge in outflows, the Peoples' Bank of China, the PBoC, in August spent $94 bn on supporting, i.e. buying, the RMB. China's total reserves of $3.5 trn stabilised in October, only to fall by another $87 bn in November. Clearly, the PBoC is having to give away lots of US dollars to support the RMB. From a monetary policy angle, supporting the RMB exchange rate represents monetary tightening: ceteris paribus, the forex portion of China's monetary base is reduced. With further capital flight to be expected against the backdrop of Xi Jinping's corruption crackdown, the PBoC no longer wants artificially to support the RMB, so it is letting it go by placing it in to this basket...

The contradiction

But given China's poor Economic Time®, Beijing can ill-afford to tighten monetarily, thereby exacerbating China's excess demand for money. Quite the opposite has to happen. Step in the basket (see next).

The basket leads to monetary loosening

So China has gone the route of Singapore, who runs the its own dollar against a secret basket of currencies. On 11th December, the PBoC announced that she would run the RMB against a basket of currencies. Our hunch is that this basket is not too dissimilar to the SDR's. As noted in the Financial Times of 21st December 2015, p. 2: "The renminbi's close dollar ties mean it is in fact one of the world's strongest performers against the surging US currency this year, having lost just 4.5 per cent to date at RMB 6.4811. Among China's trading partners, the euro has lost 10 per cent against the dollar...", all of which means that the RMB/$ has outperformed the euro/dollar rate by over 50 per cent! By hitching her currency to the other "horses" of weak currencies, she no longer has to keep squandering her monetary base by selling dollars in order to buy RMB. As long as the RMB keeps wilting less against its basket than the basket's constituents do, "the world" can hardly accuse China of currency manipulation, right? Wrong. Step in our Congress of baboons (see next).

Flak from Congress

With my years of working closely with Capitol Hill, I am afraid that deliberately ignorant American legislators won't buy this story that the RMB is holding up reasonably well against a basket of wilting currencies; instead, Congress will keep its dogged focus on that falling RMB/USD rate. Thus, expect more trade tensions between China and the US, not to mention the brewing military tensions.

How the falling RMB hurts Hong Kong

We of the SAR are now faced with rising US rates AND a falling RMB. Rising US rates hurt our property market as our already-expensive mortgages can only rise more. Meanwhile, the falling RMB means that price-sensitive mainland tourists have to spend more RMB just to buy the same amount of HKD! This puts a damper on our tourism trade, and thus on our retail sales to mainlanders. Besides, the more expensive HKD vs the RMB means that Hong Kong funds will have a tougher sell in China on account of their becoming more expensive in RMB terms to local mainland buyers.

Investment implications

Short the RMB, as well as Hong Kong's tourist-related plays — first and foremost, our hotels catering to mainlanders; also short retailers here catering to mainlanders. Go long RMB exporters selling highly price-sensitive goods.

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