China Tells

What can happen in one week? Amazingly sometimes what happens in one week is beyond what most people can expect. During this week, the expectation that Renminbi is likely to be ‘soft de-pegged’ from USD and appreciate in the near future suddenly excites the market. To start with, Mr. Benanke, the Fed chairman, expressed the seemingly most strong opinion publicly in front of the Congress on the undervaluation of RMB so far (Read Article from WSJ).

To Quote:

‘I think,….their currency (RMB) is undervalued and has been used to promote a more export oriented economy’.

Such a stance is echoed by the Secretary of Treasury, Mr. Geithner’s decision to delay releasing a congressional report possibly to label China as a currency manipulator. It is highly speculated that Washington has planned a series of political move to ‘cunningly’ seduce China government to soften its stance on the valuation of RMB, including Geithner’s visit to Beijing, to be followed by President Hu Jingtao’s visit to Washington, during which the currency issue will be put on table between Hu and Obama for a compromised move from both parties. To follow the above logic, a win-win solution is possibly achievable so that China will appreciate RMB to an acceptable extent with the government’s preferable gradual pace (eg., 3% by the end of the year), for the reward that US government is not going to label China as a ‘currency manipulator’, and not taking any additional  hostile measure against China exports (eg., punitive importing duty on a variety of goods), and shut up for the rest of the year. On the other hand, US politicians get what they want (China bows to US pressure) and successfully obtain a political medal for the election in November.

In addition to the political front, the market seems to buy into the above argument and factor in an RMB appreciation outlook. The RMB NDF has priced in a 2% appreciation in the next 6 months, which to some market participants is still too conservative. It seems to CHINATELLS that most banks and hedge funds are of the view that RMB should be revalued, and RMB will revalue. What is really amazing, is that it seems a one way bet with zero risk. CHINATELLS struggles to find any single individual or institutions who either thinks RMB should not be revalued, or thinks that RMB will not be revalued.

If there is a difference between today and say, six months ago, then it probably is the reason that market participants cite for a justification of RMB revaluation. Six months ago, the logic focuses on the responsibility of China as a world trade participant, or ‘stake holder’ as US government calls it. This time, however, the argument focuses on the point that China benefits from appreciating its currency. To start with, China might be facing a worry of inflation (See Graph from Chinatells), though it doesn’t seem so threatening yet for the moment. If RMB appreciates properly, the purchasing power of Chinese will be elevated accordingly, therefore providing a solution for the government’s effort to increase domestic consumption (mainly from imported goods though). The huge trade surplus, therefore the huge foreign exchange reserve, will be corrected through the appreciated currency, which is argued by some, including Bernanke, as the ‘culprit’ of the world financial crisis. Last but not least, allowing RMB to progressively float on the international currency market is a necessary step of government’s ambitious goal of internationalizing RMB.

Will China government buy the above argument and make the move largely in the expectation of the market? There seems little doubt. CHINATELLS is of the view that China government as a consolidated group of smart people, frequently comes up with creative measures that surprise the world. CHINATELLS deeply doubt that to bet on the appreciation of RMB (or NDF) is a free lunch on the table. To begin with, it is worth noting that China had a trade deficit in March, which is the first time in the last six years (See Graph at the top left). Such a deficit comes at the right time, and would be a waste if not fully taken advantage of. After all, if the trade pattern changes, a most important reason to revalue the RMB would be gone. Secondly, with the shrinking trade surplus, the sustainability of export growth is in question. For China government, investors have to always remember that it is not about money, it is about job, security and stability. The potential job loss in export sector simply is too large a stake that China government would even consider risking. Last but not least, the currency regime is a lengthy negotiation process with a deep political implication. The currency has been, and will always be used as a negotiation stake between governments, therefore being linked to other issues such as Iran, North Korea, Nuclear weapon and climate change. Such a nature predicts that any hope of quickly profiting from RMB appreciation would probably end up in tears.

Enough for the RMB. Now let’s move our focus to the property sector. China government started to launch measures to cool down the property market during this week (Read Article from Businessweek). Apparently the property price, particularly in first tier cities, has gone out of control in 2009 (See Graph from Chinatells). The government seems very proactive in pre-empting the formation of the bubble. Whether such measure matters, or whether it is really the intention of the government to crack down property speculation, or whether the local government has the same determination as the central government to slash the property price, is of question to many, including CHINATELLS.

CHINATELLS has long argued that it would not be in the best interest of government to ‘crack down’ property price. For the last 20 years, China government has been aggressively pro-growth and the bonus of a pro-growth model is obvious. The booming of property sector, which accounts for almost 20% of the country’s GDP, and even more for some regions, is a critical and necessary condition. A lot of people complain that the housing price is beyond the affordability and they can never afford a flat in the city even if they don’t eat and drink for the rest of the life. The point that they miss, however, unfortunately, is that it is not a question of affordability, but it is a question of income inequality (See Graph from Chinatells) and monetary policy. As long as the monetary policy is loose (eg., a near negative real interest rate), there would be active speculation in the housing market. And as long as the income gap keeps widening, there would be people who can afford a house for millions of dollars in Shanghai or Beijing.