Chinese currency Yuan or Remminbi has been rock solid until recently. This created carry trade of faking of exports, getting in foreign exchange and buying a rising renminbi. Now that the Chinese currency has dropped what happens?
There was one major emerging market currency that was not affected by the announcement of the taper last year. The Chinese renminbi also know as the yuan has never been affected by any move of the US Federal Reserve because it is not fully convertible. It is a creature of the People’s Bank of China (PBOC). While it does fluctuate, the PBOC has let it appreciate steadily since October 2010. That all changed in the middle of February.
Since interest rates in China are higher than other places and the renminbi has been appreciating for over three years, the currency was perfect for a carry trade. Even with all the restrictions, traders managed to buy renminbi and sell dollars. The trade was so large it was distorting Chinese trade figures. In January 2013 China’s exports surged 25%. In the most recent data they suffered a large drop, 18%, the largest in two years. The reason for the distortion has to do with over-reporting of exports in order to bring in more foreign exchange and take advantage of the rising renminbi. Faking invoices to take advantage of what was seen as a one way bet was a national pastime.
Starting in February the renminbi started to drop. It has fallen 2.8% against the dollar before recovering a bit. The general hypothesis is that the PBOC was trying to drive out speculators. Apparently they were successful. It is estimated that there were roughly $150 billion foreign exchange positions betting on the Yuan’s rise at the beginning of February. If the currency fell to about Rmb 6.20 to the US dollar the betters would be exposed to unlimited leveraged losses. It is now trading at 6.21.
Another view is that the PBOC is also trying to manipulate its currency to encourage exports. In theory the Chinese are trying to reposition their economy. They want it to be more dependent on local consumption and not so reliant on exports. But after 20 years it is hard to shut down the export machine. The rise in the renminbi certainly has not helped exports. The fall in exports has certainly not helped since the Chinese economy is already slowing.
It is also a problem that China and other Asian countries are having with their trading partners specifically Japan. Abenomics is the Japanese Prime Minister Abe’s plan to revive the Japanese economy. The most obvious part has been the flooding ofthe Japanese economy with yen, a Japanese version of quantitative easing, though QE on steroids.
The policy has been successful in driving down the yen by 20% since the program started in the fall of 2012. While it has increased profits of Japanese exports the main goal of increasing inflation has been due mainly to higher energy costs. There has also been a cost to other Asian neighbors like Korea, whose exports and even national dish, Kimichi, have been affected.
While last year the yen was the worst performing currency, more recently has been rising. Political uncertainty has increased the yen’s attraction as a safe haven. So despite the best efforts of the Bank of Japan the yen has risen 3.6% against the dollar.
So speculators in the yuan are not the only ones feeling the pain. The most popular and stable trade last year was to short the Aussie dollar, short the yen and go long on China, but all that is now history. Betting on the whims of central banks can be a costly mistake, but with central banks manipulating currencies on a grand scale, it is a sad necessity.
Manipulating currency can also bring about currency wars. The main grumbler is the US. Last October in a report to Congress, the US Treasury Department wagged its finger at China by criticizing its currency intervention. Even though the yuan at that time was at a three year high, the Americans maintained that it would still need a “substantial” appreciation to be near market rates. Since then the yuan has fallen 2% against the dollar. US legislators are proposing sanctions against China.
Of course they are ignoring the fact that the Federal Reserve with its $4 trillion balance sheet and quantitative easing was very successful in manipulating the US dollar by driving it down relative to other currencies. Nor did they mention the problems caused by the program to other emerging markets and the potential havoc that may occur as the program is tapered. So far the taper has ‘only’ wiped 15% off the Indian rupee and 20% off the Indonesian rupiah.
Currency manipulation by central banks appears to be a seductively easy method to stimulate growth. Just flood your economy with trillions, depreciate your currency and your exports have an unbeatable competitive advantage. This growth can be achieved without the messy politically difficult process of real reform. They just add a few zeros to their balance sheets and off they go.
But there are several major problems to this gambit. The first is that other countries can and do play the same game. Uncoordinated currency manipulation can be harmful to everyone. But the real problem is that any monetary program eventually has to stop. It is at that point that the markets take over and we find out the real consequences, which are often far worse than the issues the policies were meant to solve.
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