Why Yuan And Yen Go Together Like Yin And Yang

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by: WWS Swiss Financial Consulting SA
Summary

China and Japan are the second and third largest global economies.

There is an important amount of trade between the two countries.

The trade war with the US will help to increase Chinese trade with Japan even if US sanctions on Huawei and other Chinese companies will have a negative influence.

An important swap agreement was reached in October 2018.

The US dollar will be influenced by this development. Investors would do well to diversify their portfolios and invest abroad.

There are different ways to measure economic strength, but China and Japan have the second and third largest GDP. The projected Chinese GDP for 2019 is $14.1 trillion while projected Japanese GDP for 2019 is $5.2 trillion with the US in first place with $21.4 trillion. The Chinese economy is still growing faster than that of the US and, at the current rate, could overtake the US by 2040 if not sooner.

China GDP Annual Growth Rate

The Japanese GDP growth is muted as is GDP growth in the EU. Germany with a projected 2019 GDP of $4.1 trillion is unlikely to overtake Japan soon while India with a projected 2019 GDP of $2.9 trillion and rapid growth may overtake Germany in a few years. See the chart below for Japanese GDP growth.

Japan GDP Growth Rate

China and Japan have an important amount of trade between them. Trade relations between the two countries have improved as the US has imposed tariffs on some Japanese imports and on most Chinese imports. Both China and Japan see each other's markets as potential alternatives to diminished trade with the US. The intensification of the trade war between China and the US is likely to facilitate more trade between China and Japan. It is not clear at the present time to what extent the American sanctions imposed on Huawei will influence Chinese-Japanese trade. Some Japanese companies, e.g., Panasonic (OTCPK:PCRFY), have already indicated that they will restrict deliveries of components to China in order to comply with the American sanctions.

Trade with Japan is an important part of Chinese trade in Asia.

Bildergebnis für trade between china and Japan

The fall in the value of the renminbi could help China to export more to Japan. See the chart below for the exchange rate between the Chinese renminbi and the Japanese yen.

The swap agreement between China and Japan that was signed in October 2018 will help foster trade between China and Japan. It shows that the two countries are serious about improving trade relations. Of course, an increase in trade does not eliminate political differences and disputes on territory, especially the Senkaku Islands, not do improved commercial relations erase the historical animus of the Chinese regarding the Japanese. One can see Chinese films about the fighting between Chinese and Japanese that went on for years starting in the 1930s right up to 1945. The Chinese still remember the brutality of the Japanese occupation. Even so, the $30 billion swap agreement will mean that China and Japan can trade with each other's currency and avoid having to use the US dollar for international transactions between them.

It is difficult to estimate just how much this development will influence the US dollar. It is clear that the China-US trade war has had the effect of weakening the renminbi on Forex markets. The trade war has had an effect on the exchange rate of the renminbi and US dollar. The prospect of a resolution of the trade war helped the renminbi to strengthen against the USD. Recent developments indicate that there is no deal to be made in the near future if one will be made at all. The result has been a very weak renminbi with a US dollar now worth about ¥6.9. It remains to be seen how far the PBoC (People's Bank of China) will let the renminbi slide in what amounts to a de facto devaluation. This weakness helps to offset some of the effects of the US tariffs recently imposed on Chinese goods imported into the US. On the other hand, renminbi weakness means that China can more easily import more goods into Japan, which has not imposed tariffs on Chinese goods. Just how far the Japanese are willing to go to accommodate China for the sake of trade will have important consequences for American influence in Asia. The US dollar may be squeezed out.

Source: USD CNY

It is not clear at the present time what is going to happen to the US dollar as the trade war progresses. In the event that no solution is reached soon and the economy in China and also in the US does not prosper because of tariffs and sanctions, the US dollar may suffer as time goes on. In this case, investors would do well to position their portfolios for turbulence in the markets and a weakening US dollar. Fixed income securities, particularly government paper, can serve as a hedge against market downturns. It would also be advantageous to diversify the currencies in one's portfolio. Investment in Chile, which is the most interesting country in Latin American from a financial viewpoint, could be a good idea. Argentina should be avoided just like South Africa, where the rand has fared miserably. The Indian rupee is relatively cheap at the moment, and India offers many investment opportunities. The same holds for the Russian ruble, which has gone down as the result of US sanctions. It will probably not go down much further, and Russian companies can be interesting. The Japanese yen is fairly stable, and Japanese companies are usually fairly solid. Lastly, US investors might even want to invest in renminbi, Chinese companies, or funds invested in China. The Chinese currency has weakened because of the trade war, and it could be a good time to buy some. There is a risk that the PBoC could let the renminbi devalue even more than it has recently, but China does not want inflation inside China. The Chinese leadership is intent on promoting stability and that includes internal financial stability.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.