Chinese currency changes direction & depreciates

2008/12/04 in Tumblr blog imports

Its interesting how quickly trends can change.  Back in August of this year, I posted an article here on GloboTrends about the massive one-way bet investors were making on the appreciation of the Chinese currency.   Back then I wrote:

“Word of caution to investors:  If a shakeout ever does occur, and if foreign capital no longer sees China as a one-way bet on currency appreciation, there will likely be many local Chinese companies that will fail as they will see cheap and easy credit evaporate.  If you’re investing in China, be aware of the influence that this massive influx of foreign capital is having on Chinese banks, and their lending practices, and watch out for indicators that will surely come if the financial tides change…”

Back then, the chance of Chinese Renminbi depreciation seemed remote.  But earlier this week that momentum suddenly shifted direction, and the Chinese currency depreciated by nearly 1% in one day, the largest one-day drop in three years.

This wasnt the first time that a “sure-thing” bet on a currency movement turned out to be dramatically wrong.  A similar sudden reversal in currency direction occurred earlier this year with Vietnam, where international calls for allowing the currency to appreciate were suddenly replaced by fears of large scale depreciation.

But what is happening in China?  Is this the beginning of a new trend toward a weaker currency?  Is the move natural or state-induced?   Will this mark the beginning of protectionism?  Please join us in the forum for more discussion

A new fear enters the picture…

If in fact we are witnessing a change in Chinese currency direction, then that could have two effects.  One is internal to China where local manufacturers will be happy.

The other is with foreign investors that have invested in China with “hot money” hoping to take advantage of the rising currency (as was universally expected only a few months ago). They clearly would be alarmed if the expectation would arise of further Chinese currency depreciation as it would reduce their expected gains of investing in China.

Expectations are key.  The new danger is that If the currency direction is expected to depreciate, then foreign investors might desperately try to get their money out of China.

Not that its easy to get money out of China, what with all of the capital controls in place .  But, if they did. find a way.. then future expectations of depreciation could cause real capital flight, potentially pushing the Renminbi down for real (supply and demand based movement).  If that were to happen,  the Chinese government could interfere to defend the currency.  Rather than defending the currency by purchasing US Treasuries (as they do now), this scenario would imply SELLING US treasuries (putting downward pressure on the Dollar, rather than propping it up).  Ben Simpfendorfer at Royal Bank of Scotland was quoted in a recent FT article estimating that this risk could be quantified at $300 billion if this trend were to take shape.

Discuss in our forum here

On the Other hand…Why the Renminbi depreciation may not be worrisome..  Perhaps China’s recent surprise devaluation is not due to an official change in policy, but might be just a correction related to appreciation concerns due to ties with the US dollar (which as made Chinese exports more expensive relative to Korean ones, for example)  So, there may be good justification for allowing (engineering) a depreciation of the Renminbi vs the US dollar (especially since the Dollar has appreciated during this crisis).

Also, its possible that the Chinese will limit the depreciation to just compensate (partially) for the 20% appreciation their currency has seen vs the dollar over the past 3 years.

To see it from the Chinese perspective, its easy to understand why they would want to boost production and stimulate their economic activity at this time.  Many analysts seems to agree that China needs 6% or more GDP growth in order maintain social stability.  But, with the global market slowing down dramatically, China suddenly is at risk of slowing down below this threshold.  While no one really knows if this 6% GDP growth figure is accurate, it appears as if the Chinese government is willing to do anything to avoid testing this limit.

Danger of a Trade War:

The fear is that this might include policies to depreciate the currency in order to drive export growth.  If that were to happen, it could spark competitive devaluations among many SE Asian exporting nations for fear of losing competitiveness in their export markets.  It could also lead to trade retaliation from the US and Europe, leading to an all-out trade war.

As we speak, Hank Paulson is arriving in China and is expected to (once again) pressure the Chinese to allow their currency to appreciate vs the US dollar.  This time, however, Mr Paulson is with an outgoing administration, and is unlikely to have much success in negotiating concessions from the Chinese.  Recent reports even indicate that the Chinese are lecturing Mr Paulson about how to fix the US economy (my, how times are changing!).

Video: China’s Currency Outlook

Marc Chandler, global head of currency strategy at Brown Brothers Harriman & Co., explains why China allowed the yuan to depreciate Monday and whether further depreciation is on the cards. Interview with MarketWatch’s Polya Lesova. (Dec. 1)

External Links:

China Links from GloboTrends:

  1. Changes are happening in China
  2. China
  3. China and energy markets
  4. China internet industry
  5. China market entry strategy
  6. China trade data
  7. China’s stockmarket
  8. Doing business in China
  9. Private Equity in China
  10. Real estate market in China
  11. Rising importance of China
  12. Venture Capital in China

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