Load the Boat With the Chinese Yuan

Any doubts that the Chinese Yuan is a huge screaming buy should have been dispelled when news came out that China had displaced Germany as the world’s largest exporter. The Middle Kingdom shipped $1.9 trillion in goods in 2012, compared to only $1.4 trillion for Deutschland. The US has not held the top spot since 2003.

China’s surging exports of electrical machinery, power generation equipment, clothes, and steel were a major contributor. German exports were mired down by lackluster economic recovery in the EC, which has also been a major factor behind the weak euro. Sales of luxury Mercedes and BMW cars, machinery, and chemicals have cratered.

Back-to-back interest rate rises for the Yuan, and a snugging of bank reserve requirements by the People’s Bank of China, have stiffened the backbone of the Yuan even further. That is the price of allowing the Federal Reserve to set China’s monetary policy via a fixed Yuan exchange rate. Is it possible that Obama’s stimulus program is reviving China’s economy more than our own? That’s what highly divergent economic growth rates suggest, with China taking on 8% a year, versus only 2% for the US.

The last really big currency realignment was a series of devaluations that took the Yuan down from a high of 1.50 to the dollar in 1980. By the mid nineties it had depreciated by 84%. The goal was to make exports more competitive. The Chinese succeeded beyond their wildest dreams. This is why today’s Chinese complaints that Japan is using their country as a “garbage dump” for the yen is falling on deaf ears in Tokyo.

There is absolutely no way that the fixed Yuan rate regime can continue. There are only two possible outcomes. An artificially low Yuan has to eventually cause the country’s inflation rate to explode. Or a global economic recovery causes Chinese exports to balloon to politically intolerable levels. Either case forces a major Yuan revaluation.

Of course, timing is everything. It’s tough to know how many sticks it takes to break a camel’s back. Talk to senior officials at the People’s Bank of China, and they’ll tell you they still need a weak currency to develop their impoverished economy. Per capita income is still at only $5,000, a tenth of that of the US. But that is up a lot from $100 in 1978. I remember the grinding poverty of the “old” China all too well.

Talk to senior US Treasury officials, and they’ll tell you they are amazed that the Chinese peg has lasted this long. How many exports will it take to break it? $2 trillion, $3 trillion, or $24 trillion? It’s anyone’s guess.

One thing is certain. A free-floating Yuan would be at least 50% higher than it is today, and possibly 100%. In fact, the desire to prevent foreign hedge funds from making a killing in the market is not a small element in Beijing’s thinking. The Chinese Central bank governor says he won’t entertain a revaluation for the foreseeable future. The Americans say they need it tomorrow.

To me, that means about six months. Buy the Yuan ETF, the (CYB). Just think of it as an ETF with an attached lottery ticket. If the Chinese continue to stonewall, you will get the token 3% annual revaluation the swaps have been discounting. Since the chance of the Chinese devaluing is nil, that beats the hell out of the zero interest rates you now get with T-bills. If they cave, then you could be in for a home run.

CYB 3-11-13

Yuan - Fist Full

How Many Did You Want?

Yuan