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Monday March 20, 2006 - 11:13:23 GMT
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Yuan time?

March 20 (Bloomberg) -- China's yuan rose to the highest since a peg to the dollar was scrapped in July, as U.S. senators arrived in Beijing to seek a stronger currency.

Besides being well publicized, this senatorial excursion/vacation/reelection campaign could be well-timed because just maybe we are inching closer to the point where it is in the best interest of China for policymakers to let the yuan move higher—sharply higher.

Reading a recent piece by Morgan’s Andy Xie titled, “The Ore War,” one gets the sense that China is due for a major rethink—and they have said as much—on reducing their exposure to soaring raw materials demand and prices. The ore pricing clash between China and the major iron ore producers is for real. Mr. Xie points out that China’s extremely fragmented steel industry is already operating on thin profit margins because of overcapcity—another significant price hike for iron ore could lead to a string of bankruptcies.

The ore problem is a model for potential other problems China might encounter on the raw materials import side as the country seems to prefer building capacity at home, as opposed to importing already processed materials. The Chinese policymakers are on to the fact that this it can be extremely inefficient strategy that exposes its industries to pricing power from foreign suppliers.

What to do about this? Mr. Xie offers several ideas in his piece, such as: stockpiling raw materials, importing more already processed final goods, and enticing Chinese firms to develop manufacturing capabilities in countries where the needed resources already reside. In short, establish a comprehensive raw materials policy—one that will “scare away financial speculators.”

But Mr. Xie doesn’t mention currency revaluation. Yet, we believe the revaluation idea makes a lot of economic sense for China when considered as part of its raw material import needs. As we know, most all major commodities are priced in US$’s. Thus, any increase in the value of the yuan means said raw material import costs decrease by an equal amount—everything else remaining equal (though we know it never does).

Though no one is ever sure what the Chinese will do or when they will do it. But the economics may be shaping up to suggest that it’s in their self-interest to increase the value of their currency.
The key question: Does the relative import cost savings from a stronger yuan, which should also bolster consumer spending (wealth) on imported finished goods, outweighed any lost export dollars because of higher export prices? We may be getting close to a “yes” answer to that question. The unfortunate part is that those two US senators will do all they can to take any credit for any change in China’s policy. As they say, timing is everything.


Is the dichotomy (I always wanted to use that word in Currency Currents) in these two pairs indicative of things to come?

Japanese yen futures vs. Australian $ futures:



Jack Crooks
Black Swan Capital Subscribe to the Black Swan Letter

 

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