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Do you commit any of the 7 Deadly Investment Sins... widely-held investment beliefs that are hazardous to your wealth. Beliefs that Master Investors like Buffett, Icahn and Soros emphatically do NOT share.

“My Favorite Wealth-Building Secret”
ONE of the 23 Winning Investment Habits of Warren Buffett & George Soros stands out so much that if that’s the only one you adopt, you can kiss the days of losing money in the markets goodbye forever. I call it "My Favorite Wealth-Building Secret" and if you’ve read The Winning Investment Habits of Warren Buffett & George Soros, I’d like you to have this Special Report as a “thank you” from me.

Recommended Investment Books

Jobs for Everyone
How minimum wages cause unemployment and welfare results in misery
read article >>

Bird Flu? Bird Schmoo!! Worried about the H5N1 bird flu virus causing a pandemic? The scientific evidence suggests the media scare that the H5N1 virus will cause a pandemic is mostly hype. Read on

A Society Without Goverment that Works? Where but in science fiction, the literature of the imagination, can we skim across the surface of black holes, dive into the sun, and journey to the beginning, the end, and the edge of the universe... And visit a society without government that works?...see my introduction to Visions of Liberty

The Case of the “Reluctant” Virgin
At the age of 5, Soraya (not her real name) was circumcised, a common practice for Muslim girls in the country of her birth more >>

The Liberation of the Chinese Woman — and the Chinese Entrepreneur
How the free market freed women (and entrepreneurs) in Hong Kong more >>

How To Get A Second Passport
How To Get A
Second Passport

Read the report that started an industry — with some updated links to current information more >>

Classic Jokes
My collection of real humdingers — guaranteed to make you laugh.

Article Index

24 June 2005

Buy Yuan?

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?

After years 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.

A revaluation 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.

And since 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.

Sounds like a good deal for buyers of yuan, right?

Apparently, currency speculators around the world agree: in 2004 $1.2 trillion in “hot money” poured into China, China’s foreign exchange regulator said recently.

Before you rush in to join the crowd there are two questions you should have answers to:

1. Will China revalue the yuan? and,
2. If so, when, and by how much?

Let’s take the second question first.

The answer 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.)

Of course, it could be more and it could be sooner. But whatever it turns out to be, the ultimate profit is uncertain.

If there is to be a profit....

A major 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?

To answer 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.

Looking 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.

Secondly, 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.

What’s 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.

While Chinese 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?

Obviously, you can’t devalue the currency. That’s out.

Ideally, you’d probably prefer to do nothing. That’s usually the safest bureaucratic path.

Perhaps 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.

You could give in to the American demand and revalue the yuan by some amount that would satisfy them. Probably in the region of 25%.

The very 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.

The speculators’ $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!)

What about letting the yuan float free?

Since most everybody seems to think the yuan is undervalued, there would probably be a rush into the currency which would send it up.

But very 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.

Worse, a 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.

Frankly, 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.

One thing, 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.

So unless 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 doing. Mark Tier. 

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HomeBLOG: Money Markets & MischiefMark Tier’s Investor’s EdgeREV UP Your Investment IQDiscover Your Investment Personality
Trust Your EnemiesRecommended Investment BooksAbout Mark TierFeedbackThe 7 Deadly Investment Sins

How To Get A Second Passport
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