Figuring out the Value of Yuan

John Mauldin looks at the true value of Yuan and its impact.

Recent Chinese stock market volatility has had more to do with China’s currency than its stocks. Donald Trump and other politicians (yes, he is one) often assail Beijing for devaluing its currency and acquiring an unfair advantage.

First, the Chinese have actually been manipulating their currency upwards. While countries in the rest of the world have been letting their currencies devalue against the dollar, China has maintained an effective dollar peg until very recently. And then the “move” that seems to have everybody in a dither was only about 4%. To be fair, what really had the markets worried was that this move might presage an effective devaluation. And considering that China has watched the euro, the yen, and nearly every emerging-market currency drop anywhere from 30 to 50% against the yuan – a rather painful experience for its export sector – the Chinese have been quite patient.

Beijing think it can boost exports by manipulating its currency lower? I don’t think so. Remember how their business model works. Unlike, say, Saudi Arabia, China doesn’t simply extract resources from the ground and export them. Chinaimports raw materials, transforms them into finished goods in its factories, and then exports those goods. Their gain lies in the value added in the manufacturing process.

That means that China can’t grow exports without also growing imports. Pushing the yuan lower helps, but it’s a relatively inefficient tool for reducing the trade surplus.

Cheapening the currency has another consequence China doesn’t want. It makes imported products more expensive for Chinese consumers. The country’s abilities are growing fast, but it still depends on outside sources for many important goods. Making them cost more doesn’t help build the consumer-driven economy Beijing says it wants.

For those reasons and more, China Beige Book has a contrarian view on the Chinese currency. They believe Beijing wants the yuan to rise, not fall. So what is happening with all these interventions the Chinese authorities are making in the currency market?

The first point to remember is that the adjustments have all been quite small – far smaller than the hoopla suggests. For all the clamor that erupted last year, the yuan fell just over 4.5% against the dollar. That’s quite a lot if you are leveraged 10x, as currency traders often are, but for most merchants and consumers the change was hardly noticeable.

Recall all that happened in 2015. Aside from the stock market fireworks, China won acceptance of the yuan into the IMF’s reserve currency basket. It also watched the Federal Reserve finally make a first, tentative move toward higher rates and a correspondingly stronger dollar. If all that couldn’t crush the yuan, it’s not clear to me that anything will.

 

The second point is critical: China controls its currency by both central bank action and subtler tools. They have immense power to nudge the currency up or down. Tightening and loosening the controls is like turning a volume knob. They can crank the yuan up or turn it down.

Presently they are clamping down harder than usual in order to deter speculation. Much of this is happening under the radar, one business and industry at a time. Nevertheless, people are starting to feel the consequences.

Source: Mauldin Economics