Reminbi: Appreciation Is A Matter Of Time
There are two places in the world that is full of hot air -- hot gossips of celebrities and speculations in the stock market, and this is particularly the case when the jobs have just become more secure, and people have more leisure time to gossip and more spare money to gamble (and to lose). Since this is a financial column, and we would not like to step into the profession of the paparazzi, and therefore we will only focus on the hot air that is ballooning in the stock market. This time I will not bore you with the Macau concept again, which we have discussed several times on other occasions, but a more relevant issue -- the speculation of a potential revaluation of the Reminbi.
RMB Appreciation More Than Hot Air
Last Friday, the rumors have it that China might decide to revalue its currency in the coming few days, and Beijing could reach a decision at an annual high-level economic meeting over the weekend. When readers read this column, they might have realized that if these rumors is true or not. But my impression is that Beijing might have actually made up its mind to revaluate the RMB, and the hot air will likely precipitate into rock solid ice, the only matter is only the timing and the extent of the revaluation. Why? That is probably in the best interest of China and at the same time it can fulfill the needs of the rest of the world.
China being the world's most populated country is rich in population but short in natural resources. Since mid-2001, the US dollar has depreciated against the Euro by almost 38%, or in other words the Euro has appreciated over 58% against the greenback, and as a result of both a weakening US dollar and the persistent high growth in the PRC economy, China has imported much more natural resources, which dramatically reversed China's trade surplus from a positive ~US$6 billion in December 2003 to a trade deficit of ~US$6 billion at the beginning of this year. Due to rising prices of import raw materials, goods and services, inflation soared to a dangerous level of over 5% in the middle of this year, forcing Beijing to cool off the economy by both fiscal (austerity measures at the end of the first quarter) and monetary policies (raising interest rates for the first time in more than nine years).
If China continues to let the RMB stay pegged with the extremely weak USD, then China is risking an uncontrollable inflation and also a resurgence of trade deficits, which could be detrimental to the PRC economy in general and in particular to the banking system. For a country whose banking system has non-performing loans as a percentage of its annual GDP of over 48%, it needs to maintain a strong current account balance (both trade and net capital inflows through foreign direct investments) in order to defend against any potential attacks in the banking system. Inflation could also create social problems, as the salaries of the lower income class are unable to catch up with ever-rising prices.
Kill Two Birds with One Stone
Although raising interest rates can perform the same task, it is unable to solve the problem of rising import raw material costs. The only way to kill two birds with one stone, i.e. cool off domestic inflation and at the same time reduce potential trade deficits, is to let the RMB appreciate.
Depreciation of USD: A Conspiracy Theory
The European Central Bank (ECB) originally claimed that it might intervene in the currency market, but after the G20 meeting over the weekend it suddenly had a 180-degree change in attitude. We don't know what had been discussed during the meeting among the US Federal Reserve, Bank of Japan, and the ECB, but what we know was that they have since become silent on the currency market movements, which the market has interpreted as a agreement to let the greenback to continue to weaken. We suspect that this was probably a tactical measure to force China to appreciate the RMB.
Long before that, John Snow of the United States had said that the United States would like to adopt a strong USD policy, which we all knew that he was bull shitting, but at the same time he has neither said the Euro nor the Yen was undervalued except the apparent under-valuation of the RMB, which indirectly sent out a message that the free-falling of the USD was actually targeting at forcing the PRC government to appreciate the RMB.
China, in the meantime, has already sent out messages indicating that she is actually willing to appreciate the RMB as long as the revaluation will not invite future attacks on further appreciation, and even if that is the case the People's Bank of China (PBoC) will be able to defend. So you may say that there has already been a consensus among the international powers. The last question is only that whether the PBoC is confident of itself to defend against any potential attacks on further depreciations, and if China gets the nod of potential help from the US, ECB and BOJ, or at least paying lip service to China by saying that they are contented with the extent of the pace of appreciation.
RMB Appreciation and HK's Asset Reflation
If China does appreciate its currency, and the most likely rate of appreciation will be similar to the exchange rate of the Hong Kong dollar, which has an official rate of US$1 per HK$7.8, or an appreciation of approximately 6%.
We disagree with Mr. Joseph Yam, the Chief Executive of HK's de facto central bank, that the purpose of hot money staying in HK is use HKD as a substitute for the RMB. Mr. Yam has underestimated the IQ of the speculators. Their target is not an appreciation of the HKD but the expectation of asset inflation in Hong Kong. One argument for HK's wages failing to increase is that we have cheaper alternatives just a few steps northwards in Shenzhen. With an appreciation of the RMB, the pressure on HK's wages and property prices will at least be eased, even though some doomsayers are saying that a 6% appreciation in the RMB is far from enough for Hong Kong to regain its competitiveness. Investors who hold this view have again grossly underestimated the productivity of HK's employees.
I know that even in Quam Research Team, there are still an overwhelming number of HK bears. As always, I always tend to be the more optimistic one. With the fastest growing economy as our hinterland there is just no need to be too bearish about the future of our economy.
One last remark, since the main purpose of the free-falling of the USD is not targeted at the Euro and the Yen, when China announces the appreciation of the RMB, speculators may find them to have been made use of, and soon betrayed by the ECB and BoJ.
- written by Vincent Lam, Director of Research & Advisory of Quam (IA) Ltd., and Fund Manager at Quam Asset Management Ltd.
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