Currencies: Time to Buy Some Yuan?
Posted by admin on January 19, 2011 | No Comments
Recently, I’ve had a couple people ask me about buying yuan. Specifically, people have suggested converting dollars into yuan, opening yuan bank accounts and letting their money sit while the yuan appreciates. I suppose this idea is driven by the Bank of China’s recent announcement that it will US customers to trade yuan; and by Brett Arends recent article in the Wall Street Journal, “Do You need a Chinese Bank Account?”, in which he gives five reasons to open a Chinese yuan bank account.
To be honest, I have to disagree with Mr. Arends, I don’t think there is much to be gained by opening a yuan bank account.
China’s yuan is pegged to the US dollar and this is one of the pillars of Chinese economic policy. This has been going on for a long time, so it is true that the renminbi (aka the yuan) is significantly undervalued. But China has strong reasons for maintaining the status quo. Any appreciation in the yuan makes Chinese exports more expensive. Let the yuan rise too much, and companies start going elsewhere to buy their goods. In China, this could be disastrous. Over the last decade, masses of people have moved from the countryside into the cities as the economy boomed. If the yuan rises too much, Chinese manufacturers go out of business, and this would mean massive unemployment and urban unrest. Rest assured, this is the Chinese government’s number one fear – and rightly so.
It is true that there is significant international pressure on China to let the yuan appreciate. But seen in this light, it’s not hard to understand why China is hardly budging. China doesn’t want to, and let’s face it Americans, China is strong enough now that it doesn’t have to. Certainly, there will be some appreciation. Last year, the yuan appreciated 3.3% against the dollar. In my opinion, China is very unlikely to allow annual appreciation much greater than that.
In Mr. Arends article, he notes that right now, each yuan costs about 15.1 cents, that most economists say fair value is north of 18 cents, and that the IMF believes the value of the yuan in real, purchasing-power terms is about 27 cents. Further, he says “In the past five years, China has already allowed its currency to rise 25%. It may have plenty more room to go.”
This puzzled me a bit, so I decided to take a look at the history. Take a look at the chart below:
If we look at the chart, the yuan did appreciate from 2006 to 2008. From 2008 to early 2010, the yuan remained flat, and the yuan was allowed to appreciate in 2010. By the way, note that Mr. Arends math is incorrect. Let’s use approximate figures and say that the yuan was at about 8.0 yuan to the dollar in 2006, and that today it is about 6.5 yuan to the dollar. The change is 1.5 divided by 8.0, or 18.75%. It appears Mr. Arends may have gone in the other direction – 8.0 divided by 6.5 = 23%.
Regardless, we have to ask why the yuan appreciated as much as it did from 2006 to 2008. To me, it makes sense that the Chinese would let the yuan appreciate in a rising market. Remember at that time, world economies were going gangbusters and topping. If things are more expensive that’s not necessarily a problem as long as people are still buying. We all know that the world changed in 2008, and it makes sense to me that while the world was recovering from the 2008 crisis, China would keep the yuan low so that the world would keep buying and so that China would keep growing.
Today, we have a situation where interest rates are rising everywhere around the world except in the United States. Plus the US is in the middle of Quantitative Easing 2 (QE2). That means the dollar should remain out of favor relative to the rest of world, unless there is a crisis, such as a banking crisis in Europe. In this context, China can allow a little appreciation, because even then, it will remain cheap compared to the rest of the world. But fundamentals remain the same: let the yuan appreciate, and China risks shutting off the US market. Let the yuan appreciate even more, and it may shut off Europe and the rest of the world as well. China is not interested in either scenario.
Filed Under: Currencies