Tag Archives: yuan

A Rising Dollar, A Falling Yuan

According to a recent news from WSJ a sharp and sudden slide in China’s yuan is forcing investors to rethink one of the most reliable trades in financial markets over the past four years: betting on gains in the Chinese currency.

Screen Shot 2014-04-12 at 6.10.28 PM

Since China resumed efforts to move the yuan higher in 2010, traders have piled into bets that profited as the currency has staged a seemingly relentless advance. But after hitting a record against the dollar in mid-January, the currency has dropped over 1%, reaching a six-month low on Tuesday.

China hasn’t intervened much in the market lately while the direction of the yuan has headed downward due to market pressures. A broad range of economic indicators—from trade to consumer spending to industrial production—have showed a slowing Chinese economy, which has reduced demand for the yuan. On April 16, China plans to report its first-quarter gross domestic product numbers and it is widely expected to show a slowdown to somewhere around 7% year-over-year, from 7.7% in the last quarter of 2013.

Most market analysts expect the yuan to reverse course over the year and finish with modest appreciation. That is because of a combination of factors: China’s economy is likely to pick up somewhat later in the year as Beijing makes moves to stimulate its economy. At the same time, its leaders realize that a steadily depreciating currency is bound to cause friction with the U.S. and other trading partners.

However, according to U.S. Treasury Looking Closely as Weaker Chinese Yuan: the U.S. put China on notice that it is looking closely at whether Beijing’s efforts to devalue the yuan represent a shift in policy that could start a round of competitive devaluations. A senior official at the Treasury Department said it would “raise serious concerns” if Beijing is moving away from plans to allow market forces to have a greater impact on the yuan’s exchange rate, especially if Chinese officials are at the same time citing greater flexibility in the currency’s movements.

Is it good for Chinese people as Yuan is falling? The answer is positive for China but negative for the United States. This is why USA doesn’t want Yuan to fall. Firstly, falling Yuan will decrease imports since the price of imports will become higher under weaker Yuan. Secondly, exports will increase due to the same reason. Thus, there will be an increase in the labor market in China since China needs to produce more. In this way, falling Yuan will definitely benefits China but hurts US economy. So will China take any actions because of the warning from U.S.? Let’s wait and just keep an eye on the exchange market.

 

The Fall of the Yuan and Why It Will Benefit China in the Long Run

A recent article in the Wall Street Journal, “Falling Yuan Curbs Cash Entering China,” paints a rather grim picture of the effect of the recent fall in the yuan’s value on Chinese small and medium sized businesses.

A quick update on what has been happening to the Chinese currency recently: on Saturday, in an effort to stop speculators from betting on the yuan’s appreciation, the People’s Bank of China expanded the band inside which it would let the yuan move (on a daily basis) from +/- 1% to  +/- 2%. The hope is that the increased volatility in the currency will deter foreign investors from moving money into China in expectation of potential gains made from the appreciation of the currency. The yuan has been steadily appreciating since 2005 and it looks like the PBOC has finally gotten sick of the foreign freeloaders. The reason this foreign inflow of capital is troubling for the PBOC is because it inflates prices on property and other assets, causing them to be overvalued, and increasing the risk of asset bubbles and large scale recessions.

The article emphasizes that the PBOC’s strategy seems to be working:

During Asian trading Wednesday, the currency fell further, boosting the dollar to 6.2040 yuan, marking a 1.1% drop relative to the parity rate. It was the first time the yuan had traded beyond the previous 1% band. Foreign money entering China fell to a five-month low of $21.1 billion in February, according to central-bank data released this week. The total compares with $72.3 billion in January.”

The article goes on to point out that not only foreign investors, but also many Chinese small businesses had been profiting from the currency appreciation. Banks were selling derivative products to these businesses and many of them have been hurt by the yuan’s drop in value.

Although I would agree with the article when it asserts that small and medium sized businesses will be hurt by the falling yuan in the short-term, I believe that the PBOC is making the right move here because this action helps to ensure long-term price stability and steady economic growth. Furthermore, the fall in the yuan may increase the already large demand for Chinese exports, which would bolster GDP growth and perhaps get rid of some of the investor doubt about China’s ability to sustain it’s large growth in the future.

In order to test this hypothesis, I did some research into some of the data on Chinese exports and have been somewhat confused by what I found. It looks like Chinese exports undergo pretty apparent cycles each year, enduring severe drops at the beginning of each year and proceeding to sharply increase and fluctuate a bit throughout the rest of year:

China Exports 2009-2014

China Exports 2009-2014

At first I thought this cyclic nature was just a result of how tradingeconomics.com measures exports, but looking at the graph of Australian and other countries’ exports has convinced me otherwise. Australian exports do not exhibit the same sort of distinct cycles each year:

Australia Exports (2009-2014)

Australia Exports (2009-2014)

If anyone has any insight on why Chinese exports exhibit such clear cycles I’d be interested in hearing what you have to say. I did a bit of googling and haven’t been able to find anything of substance. Am I overlooking something obvious?

 

 

China’s Banking Purgatory

As of yesterday, the Yuan fell to its lowest value relative to the dollar in ten months because the Chinese government “doubled the currency’s daily trading range” over the weekend.  With the goal of reducing capital inflow so as to decrease the risk of asset bubbles, this policy is part of China’s plan to replace strict currency controls with financial regulation.  Ultimately, China hopes to achieve greater financial stability in doing so.

Personally, I find this rhetoric hard to believe.  We learned in class that China benefits from reduced capital inflows.  Reduced capital inflows imply an increase in net capital outflows, which in turn leads to a boost in China’s net exports, a depreciation of the Yuan, and an increase in GDP.  For this reason, it seems hard to believe that China is committed to loosening currency controls.

This wishy-washy policy is what places China in “banking purgatory.”  By directly impacting financial institutions and private banking, China’s inconstancy places it in an awkward purgatory between fully controlled markets (economic Hell) and capitalism (economic Heaven – obviously my opinions are made very clear here…).

Specifically, China’s wishy-washy policy impacts banking and financial institutions in the following way: given China’s commitment to decreased currency manipulation, many private firms in China (both financial and non-financial) have already pursued billions of dollars worth of options contracts to hedge against an appreciating Yuan.  That said, when the government steps in and redirects changes in the Yuan’s value, these options generate losses for private firms.  In 2014, the Yuan is down 2% relative to the dollar, and this depreciation has resulted in over $2 billion of losses for Chines firms.

For Chinese firms making exportable goods, the losses on these options are minimized by a boost in exports.  However, financial firms, which do not usually export any tangible goods, are not so fortunate.  Given the already unstable state that Chinese financial firms are in (the government is just beginning to warm up to private banking), these losses could have significant implications for shadow banking.

China’s currently uses a public banking system.  This policy has ultimately hurt small businesses, as it is harder for them to meet the strict borrowing requirements set out by a highly risk-averse institution like the Chinese government.  Unable to qualify for public loans, small business turn to shadow banks instead, which force many small businesses into unaffordable loans (shadow banks are financial intermediaries that carry out typical banking activities like commercial lending, but without the limits of traditional depository regulations).

Because China’s small businesses cannot qualify for public loans and cannot afford shadow loans, they are left with very few options for sustainable growth.  Given that small businesses in China are responsible for 60% of China’s GDP and 75% of China’s new jobs, this predicament poses a serious threat to China’s economic sustainability.  A simple solution would be to allow for private, regulated, banking.  And in the beginning of 2014, China did just this, approving a pilot plan for the establishment of 3-5 private banks.  That said, given the losses that Chinese financial firms are experiencing currently (caused by the government’s currency manipulation), I find it unlikely that the proliferation of private banking will come anytime soon.

In this way, China is stuck in an uncomfortable middle ground on its way to economic deregulation; like the Catholic destined for heaven but in need of purification, China is struggling in purgatory as it develops into a capitalist economy.  While China has committed verbally to currency deregulation (a very good step in my opinion), the country’s policies do not yet align with this verbal commitment.  Certainly, it is difficult for a country as big as China to abandon such an engrained tradition of currency manipulation.  But until China commits to doing so, inconsistent policy will plague financial institutions, which will in turn reduce the chances of successful private banking and increase the pain small businesses feel from shadow banking.  Complete commitment to looser currency controls is therefore necessary for China to escape its banking purgatory and fuel sustainable, long-run growth.

Possible Reasons of Why China Weakens Yuan

According to news from WSJ, China’s central bank weakened the daily reference rate for its currency by the largest percentage in more than a year and a half, continuing a push to drive the yuan lower. As sluggish economic news sent jitters through the market, the People’s Bank of China set the daily reference rate Monday at 6.1312 to the dollar, compared with 6.1201 to the dollar on Friday. The 0.18% change represented the largest one-day move in the rate since July2012. (China Weakens Yuan by Largest Degree Since 2012)

It is so strange since 2005, it has gradually moved the rate up, allowing the yuan to strengthen 33%, but in the last month has pushed it lower, seeking to discourage speculators who have channeled money into the economy in hopes of benefiting from the currency’s rise.  But luckily, it’s not as bad as it looks. Or one should hope. China is still a closed economy. The government controls the foreign exchange rate. But one look at a USD-CNY chart and it’s obvious that the Central Bank of China is worried about something. Either a slow domestic economy, or a worsening international one.  (Why The Chinese Yuan Is Weakening Against The Dollar)

In this blog, I’ll try to guess possible reasons for this change in the trend of Yuan. The first assumption people think is this is done by the government intervention, in order to better control the market. This action has the benefit of introducing more two-way risk in to the currency, which is prudent from a long-term financial markets reform perspective.  Moreover, it could curb the future growth of carry trade-related inflows that otherwise would complicate the Chinese authorities’ goal of deleveraging some parts of the economy.

The second assumption is because of US dollar strengths recently, making the ratio US dollar vs RMB change. A commonly held belief among foreign-exchange strategists is that 2014 will be the year of the dollar. That includes strength against the euro, which is up 4.1% against the greenback to date. (Don’t expect dollar strength against the euro in 2014: Goldman Sachs) Obviously, it will do the same to Chinese Yuan.

The third assumption is from central bank and the policy side since there has been a shift to a more neutral policy in a context of weakening growth momentum and looming signs of problems in the financial sector. If this is the main motivation behind policymakers weakening the currency, then it leaves the door open to further official dollar buying to drive depreciation if growth were to falter further

 

Double Edged Blades of Chinese Exchange Rate Policy

Yuan, Chinese currency, was once had a fixed exchange rate policy until a managed floating exchange rate regime took over its place in 1994. Then, what is this managed floating exchange rate? China operates managed floating exchange rate which intended to reflect market supply and demand of Chinese currency, yet allowing government to control the rate by keeping exchange rate in a certain range. There are many debates about Chinese exchange rate policy around the world, especially within the United States, because undervalued Chinese Yuan hurts U.S. net exports and jobs. The reason is because; China can produce goods and labor relatively cheaper when their currency is undervalued. This is also exactly the reason why China keeps and wants to control their exchange rate in this manner. Moreover, China’s growth is heavily depend on their exports of goods and services, and undervalued Yuan gives comparative advantage on Chinese goods and services. A relatively stable and predictable Chinese exchange rate allows investors and their trading partners around the world to have a bigger room for their risk management strategies thus attracting more investments opportunities. In contrast to the positive sides of managed floating exchange rate, I agree with a WSJ reports saying that China’s Currency Move Leads to Liquidity Boost, and this can cause a serious trouble for China in a long run.

As market witnessed, China has been lowering their currency value in the past two weeks and this is not led by the market but clearly the government intervention. If you read, China Intervenes to Lower Yuan, I am sure you will be well convinced that Chinese central bank has tethered their exchange rate. As a result, their action led investors to buy U.S. dollars and sell Yuan which led short-term interest rates to rise in China. According to WSJ reports, this is contradictory of government’s forward guidance in last June.

That has caused concern among economists, because it contradicts Beijing’s campaign since June to keep borrowing costs high to rebalance a credit-driven economy and rein in risky financing such as the loosely regulated “shadow-banking” sector.

According to Teck Kin Suan, an economist at United Overseas Bank in Singapore, deleveraging economy acquires high interest rate and tight liquidity, yet weaken currency make more liquidity flow in China. This is where I got an idea of “Double Edged Blades”. To support Teck Kin Suan’s claim, I would like to present a simple example. Suppose Chinese exports had increased because of their weakening Yuan policy, more exporters from China will receive their payments in US dollars and those US dollars received needs to be exchanged to Yuan. In a theory, this has to create upper pressure in value of Yuan, thus balancing supply and demand of Chinese currency, however this upward pressure has been artificially prevented by the government intervention in China. Regardless of their intervention, exporters must exchange their dollars to yuan. This case, Chinese government is left with no choice but accumulating dollars in their banks and give yuan to domestic exporters, thus increasing money supply in China.

I believe this can cause a high inflation in China, simply because more money is circulating in Chinese markets. Second, money is not recycling. Precisely, dollars that are accumulating in Chinese Reserve are not circulating. When this happens, China is not only losing their money in terms of dollar because dollars sitting in the Chinese Banks are counted as a huge opportunity costs. In addition, when U.S. dollar depreciates, it also counts as a huge loss to China. One can argue that it can be a huge gain when U.S. dollar appreciates, however China seems not to use this “hot potato” anywhere but just keeping in the their vault.  I am not sure how big the benefits of having a managed floating exchange rate are compare to the risks of accumulating a huge foreign currency. It seems to me that risks are getting stronger than its benefits.

 

China Loosens Grip on Yuan

If there is one thing that has been as reliable as the sun rising daily over the course of the last couple of decades, its the fact that China manipulates its currency and that the US follows by deeming China a currency manipulator. Interestingly enough though, this “broken record” type situation may soon be coming to a close.

As China has faced massive problems with liquidity in its deregulated shadow banking sector as well as a credit crunch that has plagued the country recently, concerns about growth and credit stability have taken center stage. (WSJ) Chinese financial leaders seem to now be realizing that steps need to be taken in order to improve their own global financial position and that means taking a look at their currency.

The Chinese have what is referred to as a “pegged currency” — they control or peg their exchange rate to another currency (ie: the USD) in an attempt to make trade easier for all parties involved and keep expectations constant. One of the side effects of a mechanism like this is the weakening of the pegged currency and the loss of the ability control interest rates and money supply — because you constantly have to be able to absorb any increases in supply as well as satisfy any excess demand as well. China does this in order to make their exports cheaper in foreign currency terms. As we have talked about in class, a weaker Yuan leads to more demand for the currency due to cheaper exports, which leads to a higher GDP.

The sustainability of a mechanism like this has always been scrutinized but has never seemed to bother China (and why would it with 10% y/o/y GDP growth) but that seems to be changing before our own eyes. In China’s pegging scheme, the central bank controls the range in which the Yuan/USD is allowed to fluctuate (See the image below)

P1-BP270_PBOC_G_20140226185704

 

This range has been about 1% movement in either direction historically but the central bank is rumored to be preparing to let it broaden to 2 or 3% in either direction. (WSJ) Now while that may not seem like much, it may signify the fact that China is realizing that its economy is changing and is ready to adapt (the call being for a free floating currency eventually). The WSJ article also points out that another motivation for the movement to a free floating currency may be that China’s real goal is to overtake the dollar as the world reserve currency eventually. This seems like something of a pipe dream, but enough people use the Yuan that it might not be out of the question. All in all the loosening of the currency grip will be a good thing for the dollar and the US because it may force outflows to China to stay in state and boost GDP here.