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Tuesday May 10, 2005 - 10:57:48 GMT
Black Swan Capital - www.blackswantrading.com

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More to "revaluation" than meets the eye

Quotable

“I interpret financial markets as a historical process. I believe my interpretation also has some relevance to history at large—by which I mean not only the history of the human race, but all forms of human interaction. People act on the basis of imperfect understanding and their interaction with each other is reflexive.”

George Soros, The Crisis of Global Capitalism

FX Trading

You have to wonder what the politicos are thinking. Let’s say you own a cabinet making shop. You pay your workers $0.40 per hour to build cabinets. I own a competing shop down the block, and I pay my workers $6.00 per hour to do the same job. But the local politician says that it’s unfair competition for you to pay your workers just $0.40 per hour. So, he says in order to make it fair, you should raise your workers salaries by at least 40%. So, you relent and pay them $0.56 per hour. Now, the local politician feels good and can tell his constituents he just leveled the playing field—no more unfair competition on his watch. Does this sound familiar?

How on earth is a Chinese revaluation of 20% or even 40% [and it’s highly unlikely we see a revaluation of that magnitude, if we see one at all] going to level the playing field in terms of trade? I am no economist, but on the outside looking in, those numbers just don’t add up to much. Yet the politicos would have us believe it to be so.

But what is interesting is that a revaluation of that size could change the terms of trade for China vis-à-vis its other slave labor nation competitors.

This is from a piece by Stephen Jen, at Morgan Stanley:

“I believe the RMB is modestly under-valued both in index terms and against the USD. Moreover, the popular guesstimates in the 40% range are too high. I also doubt revaluation will contribute to normalisation of global imbalances. Global imbalances reflect disparate savings-investment (S-I) imbalances in the world, and the process of globalisation, not exchange rates. Previously, I have stressed the low price elasticities of trade demand for the US, and the price substitutability of goods produced in China and other emerging economies. If an RMB revaluation shifts production from China to other not-so-low-cost emerging markets, the US C/A deficit could deteriorate further!” [My emphasis]

Can you just imagine it! The law of unintended consequences kicking into play when politicians rear up on their hind legs to solve a problem!

Mr. Jen doesn’t believe China has manipulated its currency for trade gains—he believes the huge foreign exchange reserve balance is because of hot money pouring into China.

And I believe most people would agree that much of the hot money flowing to China is precisely because the people on the other end of the flow believe China’s currency is 20-40% undervalued and they will see a revaluation of that magnitude. But, ask yourself this, what happens if China decides to wait another year or two before revaluing? Or what if it does the deed and it turns out the much awaited revaluation is miniscule relative to expectations? I would imagine that the hot money people would be disappointed.

Mr. Jen cites an IMF study: “They [IMF] found that close to 75% of the change in capital flows came from categories of flows sensitive to market expectations on the future trend of USD/RMB, rather than the underlying fundamentals, i.e., without ‘speculative’ inflows, China’s reserves would have been US$455 billion at end-2004, rather than US$609 billion.” [My emphasis]

That’s $154 billion in hot money flow. If that goes the other way—I would imagine it would have a significant negative impact on a Chinese economy [global growth engine #2 of 2 besides the US] in need of funds to keep the music playing—and it would probably be a little boost for the buck!

So, as we’ve been told before: Be careful what you wish for, it may come true.

Jack Crooks

 

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