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Friday January 6, 2006 - 11:33:06 GMT
Black Swan Capital - www.blackswantrading.com

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China transition and yen catch up?

Quotable

“Time is that wherein there is opportunity, and opportunity is that wherein there is no great time.”

Hippocrates



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We’ve been seeing rumblings from the Chinese of late related to both diversification of their vast foreign exchange reserves and possible revaluation of the yuan. The consensus view, of which we are part of, is that China cannot afford to allow the yuan to move “too much” higher in the “near-term” against the US dollar, lest they jeopardize the engine of growth—exports.

“The basic arithmetic of the US-China economic relationship remains a mutually beneficial one. The US has a vast current account deficit, which China helps to fill by buying US Treasury bonds. That has the dual benefit of keeping the US economy afloat on a sea of relatively low long-term interest rates, while protecting the value of the dollar, thereby ensuring China’s exports remain competitive (though controversial) in American markets,” writes Gerard Baker of The Times.

At some point we know the arithmetic will change. That point will likely not be a crystallizing event, but a subtle and growing confidence that China is making the transition from an economy highly dependent on exports to one that can grow adequately from domestic demand. The question is how fast can they get there?

Below is a chart from The Bank Credit Analyst (BCA). It shows the relative contribution to China’s GDP from capital spending is declining, while the private consumption contribution is rising:


Source: The Bank Credit Analyst

BCA believes the growth on the consumer side is for real and will support 8-9% GDP growth in 2006 despite an expected slowdown in exports to Mr. US Consumer this year. “Policy makers stand ready to pump-prime with fiscal and monetary stimulus,” writes BCA.

From The Standard newspaper yesterday [our emphasis]:

"China's economy seems to be growing in a healthy manner, without big ups and downs," said Li Huiyong, a Shanghai-based analyst at Shenyin Wanguo Securities. "However, investment is still growing at a fast pace, and a capacity oversupply is eroding companies' profitability."

To refocus growth from investment, Premier Wen Jiabao has vowed to encourage domestic consumption in 2006 by adopting a series of measures, including boosting investment in education and rural infrastructure, and raising urban incomes.

"China will roll out more policies to induce consumption in 2006," the State Information Center said. It forecast that China's retail sales will increase by 13 percent to 6.88 trillion yuan this year.

It is not lost on Chinese or American policymakers that once this transition to a more consumer driven Chinese economy is made, a rising yuan will reduce China’s imported energy costs and enrich its consumer. And with wage rates low AND increasingly improving infrastructure, the manufacturing advantage is not likely to slip away anytime soon regardless of how high the yuan rises.

China’s neighbors hope a rise in the yuan comes sooner rather than later. As you can see in the chart below, the South Korean won and Singapore dollar have rallied sharply against US dollar of late. This chart also begs the question: Is it time for the yen to play catch up?



Jack Crooks
Black Swan Capital

 

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