In my yearend projections for 2010 I said (among other things) the following:
-China will surprise us all and revalue the Yuan by 10%. The currency will still be undervalued.
On Monday morning Bloomberg has a story out quoting Goldman’s Chief European Economist as saying:
Feb. 15 (Bloomberg) -- Goldman Sachs Group Inc. Chief Economist Jim O’Neill said China may be poised to let its currency strengthen as much as 5 percent to slow the world’s fastest growing major economy.
I doubt that Mr. O’Neill is making a guess here. I think he may have some real insight on this. When he says this, I listen:
“I have a strong opinion that they’re close to moving the exchange rate,”
Say this story is true and in the not too distant future China will adjust its currency against the dollar by a reasonably significant amount. Assume that they move by 5%. What might this mean in the scheme of things? What are the market implications, if any? Just some thoughts.
-If China does do something significant, it is another sign that should not be avoided. Something is up with China. They are changing direction. A currency move this week followed by the monetary moves last week is a clear indication that things have heated up, and they don’t like it. The two steps (assumes currency reval.) would prove that Chanos etal. were right all along. There is a bubble.
-If you were China Inc. and you owned the IOU’s behind a monster amount of empty buildings (and cities) the last thing you would do is to strengthen your currency and tighten monetary policy. But if the arguments in favor of reversing stimulus outweigh the consequences of extending fast money policies then it is not hard to predict that those empty buildings will remain so for a while to come. There would appear to be some urgency to the Chinese steps, should they occur.
-Should this happen it would come at a very inconvenient time. China’s currency is tied to the dollar. The dollar his risen against the Euro by 10% in the last two months. Therefore China’s currency has risen by the same amount against the Euro Zone. That is a big market for China’s exports. If they revalue against the dollar by 5% and the dollar stays where it is they will have taken a 15% hit on the terms of trade in just 60 days. If I were China I would be putting out the story, “Our currency is up 10% versus half the world. Stop yapping at us to make it higher still”. So that makes the timing of this (should GS be correct) very suspicious in my mind.
-All else being equal I would rate this a win-win for the Euro Zone and Brazil (again), a win-lose for the USA and a lose-lose for China. For the US it might be of some benefit to the big exporters, but I doubt it. Any improvement on pricing will be offset by a reduction in demand. For all of those Wal-Mart and Home Depot shoppers beware. Prices are going up.
The market outlook on this is murky for me. There are some checks and balances to this that could in theory bring some stability. Everyone has been leaning on the Chinese to hike their currency. So if they were to do it the spin would be, “Hey! Here’s some Good News!” I don’t see it that way.
-Last week the market tanked on the news that China was moving on reserves. This is no different. So if it was bad last week. It will be bad this week too.
-Should this happen it raises a big question about the HK dollar. Logically that would have to be re-pegged as well. Should that not take place I would expect a mega move into the HK$. I can’t imagine that the Central Bank will accommodate that.
The money flow to Hong Kong has been big and steady for some time. The reserves were $206B as of 12/31/2009. Should there be an adjustment in the HK$ rate there would be some very big overnight profits. At some point thereafter the reserve flow would reverse to more normal levels. Say 50% or $100b. That just means there is one less buyer of US Treasury bills at the next auction. Most of the hot money that went to HK was borrowed, so when the short-term flows are reversed the margin debt is paid down. There is no new or alternate buyer of those Tbills.
-China was supposed be a global engine for growth. Whatever your expectations were on that score a week ago you must revise them down today. A year ago there was all the talk of green shoots. There were many of them. China tightening its belt at this time and at this pace is a brown patch. In Europe there are dead tumbleweeds blowing around. These things do not make for an improving growth story.
-Using the wisdom of purchasing power parity an argument could be made that the Euro would be a tad undervalued should the Chinese move. I don’t see that happening either. Much to the chagrin of the Chinese the dollar could go right on rising. To hell with purchasing power parity.
-If you read the Chinese steps as deflationary, it has to be bearish for the commodities. They have all been backing up. This could cause that to continue.
-Gold could be interesting. Say the thoughts on the dollar were right and we move toward 1.30. Say the commodity markets followed that lead. That would imply that gold should move lower in sympathy. I would watch that one. These things that may be coming are on the side of the shelf that is marked: DESTABILIZING. I am not sure if this will come into the gold equation at this time. It will soon enough.
-In this environment the TLT is not the place to be. Not yet.
-On paper this could mean that China has less exports and more imports. Should that be the case their reserves will stop growing. Who is it that is going to be buying all of the paper that is being created by all of the debtors in 2010? At the moment I am having trouble of thinking of any ‘size’ buyers. Possibly Ben B will have to add some more demand to meet the supply. That would be very big tumbleweed.
The GS report got me to write these thoughts. This is all just blue-sky thinking. Probably nothing will come of it. I hope not.
(from Bruce Krasting's blog, February 25, 2010)
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