How fast will the Chinese revalue to dump dollars?
From Andy Lees at UBS this morning:
The first chart shows US import prices from China are back to their highs of 2008. The price of US imports from China is going through the roof. The second chart shows the Chinese terms of trade which are similarly getting back to the lows of 2008. Whilst Chinese export prices may be soaring, they are collapsing relative to the price of its imports. Export margins must be collapsing. China’s energy inefficiency means its terms of trade will affect it more rapidly than other more efficient countries.
The Renminbi has appreciated by 5.67% against the US dollar since the MOF started allowing it to rise in June last year. Over the same period the RMB has depreciated by 14.54% against the euro which is its bigger trading partner – (over that period the euro dollar has risen from 1.1877 to 1.4490). Far from revaluing the currency, China is fast devaluing its currency as its faced with a loss of competitiveness, and yet despite this its FX reserves have soared as its capital account has seen huge inflows.
We know that domestic credit growth in China is at totally unsustainable levels. The PBOC themselves tell us that on & off balance sheet credit growth is about 30% GDP whilst Fitch says its nearer 40%. Either way its huge and totally unsustainable. I am still of the view that China can keep the game going on a little further, and that it will be bailed out by another round of restructuring in the West which negatively impacts commodity prices, but the risks – (the difference between the current account and capital accounts) – are becoming increasingly off-the-scale.
Andy is writing here first and foremost about import inflation into the US. However, the rate of Yuan appreciation is something to watch given recent comments coming out of Beijing about US political and economic dysfunction. The Chinese are saying they want to diversify out of US dollars because the currency is weak and the economic and political risk too great.
The US dollar has been relatively weak in the past year (remember dollar-euro parity talk last year?). Andy notes the rise in Euro-Dollar but the US dollar has depreciated against all of the majors except Sterling and the Yen, which is near its historical US dollar high already. The Swiss franc and the dollar bloc (Canada, Australia and New Zealand) have all appreciated. The Swiss franc has always had a safe haven stauts but Canadian government officials are also talking about the Canadian dollar’s newfound safe haven status too. In Australia, rising inflation will keep the currency elevated.
With the Chinese currency pegged against US dollars, and the US dollar depreciating, the Yuan has been depreciating instead of appreciating against its other major trading partners That’s a problem. As I put it, when discussing the potential re-emergence of the currency wars in April:
Now that the Fed has confirmed it won’t raise rates and the dollar is dropping, for me it means the currency wars are back on. I suspect this time around China will get the stick instead of the US because of the Dollar peg. What China should do as Chinese inflation spirals ‘out of control’ is not just tinker with reserve requirements and slowly raise rates. They need to revalue much more aggressively. Instead you see China potentially adding fuel to the commodity rally by diversifying reserves out of US dollars, making the inflation problem worse. It doesn’t sound like the Chinese are very serious about their inflation problem. I reckon other emerging markets will see this combined with the plummeting dollar and cry ‘foul.’ And so when the currency wars re-ignite, it will be the Chinese under the gun instead of the US.
If the Chinese are serious about their anti-US rhetoric, they will have to do a lot more on the currency front. First and foremost, they need to move more aggressively to a basket peg that allows bilateral Yuan currency rates to move as the relative value of currencies in the basket move. Pegging to a basket that included currencies like the British Pound, the Euro, the Japanese Yen, the Brazilian real, or the South Korean Won would instantly get rid of the excessive exposure to the US dollar. Beyond that allowing the currency to appreciate faster or to float would be the next most logical moves.
Just because the Yuan floats doesn’t mean there would be no trade surplus. The euro floats and the Germans have a trade surplus with the US. The Japanese yen floats and the Japanese have a trade surplus as well. In the end, the US is still the world’s reserve currency and every nation is looking to accumulate US dollar reserves. For that reason, there really is no way around exposure to the US dollar. However, if China wants to dump dollars, it should stop the chatter and put its money where its mouth is: Revalue faster or float; everything else is just hot air.