If the revaluation
of the Chinese yuan is
a sure thing, as everyone seems to think,
buying yuan is a guaranteed way to
make money. But is it?
of American pressure on China to revalue its currency, the yuan,
Congress is now threatening to impose a 27.5% tariff on all Chinese
imports within six months if China doesn’t revalue —
or float — its currency.
would give speculators who’d bought yuan an instant —
and guaranteed — profit.
Let me explain.
Since 1996, the Chinese yuan has been fixed at a rate of 1 yuan
= 12 US cents. If the yuan was revalued it would be worth more
... say, 15 cents.
this will be a new fixed rate, the government of China would,
in effect, be committed to giving 15 cents to each person who’d
bought yuan at 12 cents.
a good deal for buyers of yuan, right?
currency speculators around the world agree: in 2004 $1.2 trillion
in “hot money” poured into China, China’s foreign
exchange regulator said recently.
rush in to join the crowd there are two questions you should have
China revalue the yuan? and,
2. If so, when, and by how much?
take the second question first.
to this question is simple: nobody really knows. Say China revalued
the yuan by 10% two years from now. That would give you a 5% per
annum return on your capital. Not very interesting. (And nor would
it satisfy the Americans.)
it could be more and it could be sooner. But whatever it turns
out to be, the ultimate profit is uncertain.
is to be a profit....
attraction of buying yuan is the general assumption that there’s
no downside risk because there’s only one way that Chinese
currency can go: up. But is this true?
that question, imagine you’re president of China’s
central bank. You have four choices:
1. Do nothing;
2. Revalue the yuan;
3. Devalue it; or,
4. Float the currency — so its exchange rate would be set
by the free market instead of government fiat.
at the economic data, it’s hard to find anything that would
justify a revaluation. For example, according to a Federal Reserve
Bank of Cleveland analysis, in the 10 years the yuan has been
fixed to the dollar, its real value has actually fallen against
the greenback -- if only by 2.4%. That implies its really worth
less than 12 cents.
that $1.2 trillion inflow of “hot money” that I mentioned
above, when converted into yuan, has caused China’s money
supply to explode. It was up 14.4% last year, compared to and
increase of just 2.7% in the US.
more, in the past six months, as Fed chairman Alan Greenspan has
tightened the screws, the supply of dollars (using the M1 measure
of the money supply) has actually declined.
yuan have become more abundant, dollars are actually getting scarcer!
You don’t have to be an economist to figure that the dollar
should rise in value and the yuan should fall.
So, as president
of the central bank of China, faced with this American ultimatum,
what are you going to do?
you can’t devalue the currency. That’s out.
you’d probably prefer to do nothing. That’s usually
the safest bureaucratic path.
you could try and persuade American politicians that their demands
are illogical. But logic is a poor tool to use with people who
are blinded by their emotions and politics.
give in to the American demand and revalue the yuan by some amount
that would satisfy them. Probably in the region of 25%.
next day, however, the speculators would all be knocking on your
door wanting to turn the yuan they bought for $1.2 trillion back
into dollars at the new, higher rate: you’d have to pay
out $1.5 trillion.
$300 billion profit would come straight out of your foreign exchange
reserves. Better to let the Americans impose their tariff. After
all, that wouldn’t affect Chinese exports to the rest of
the world; and you’d keep your foreign exchange reserves
intact. (In any case, most Chinese goods would STILL be cheaper
than the alternatives — even with the tariff!)
letting the yuan float free?
everybody seems to think the yuan is undervalued, there would
probably be a rush into the currency which would send it up.
quickly, speculators who are already there will start to take
their profits, pushing the yuan back down. That could easily trigger
a rush for the exits, sending the yuan into freefall.
collapsing yuan could easily expose the serious weaknesses of
China’s banking system, sparking an economic crisis the
fixed exchange rate was designed to avoid.
I have no idea what the president of the central bank of China
is going to do — and I’m very thankful that I’m
not in his shoes. But I imagine he’ll move heaven and earth
to avoid giving speculators a $300 billion profit.
though, is clear: as is usually the case in the markets, what
seems to be a “sure thing,” with a guaranteed profit
and no downside risk, in reality has a return somewhere between
zero and something, with a very high chance that you could lose
a bundle of money.
you’re George Soros, and currency speculation is firmly
within your “circle of competence,” probably best
to leave this one right alone. That’s what I’ll be
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