Does anybody think the Chinese yuan is over-valued against the dollar these days? Maybe the Chinese yuan-dollar peg makes the yuan too strong.
Andy Xie can’t help but be disturbed by the fact that almost everyone on Wall Street thinks the yuan will appreciate right now should China let it float freely. Wall Street has gotten some of its largest calls wrong in the past of course.
On the surface, it seems self-evident that the yuan is under appreciation pressure. Like any product, a currency’s value depends on supply and demand. When the two are mismatched, foreign exchange reserves rise or fall. China’s foreign exchange reserves have risen massively in the past five years, which means demand for the yuan has exceeded supply. This could be viewed as prima facie evidence that the currency is undervalued.
Some argue that pressure for a rising yuan is not a bubble by noting that China’s large trade surplus contributes to about half of the increase in foreign exchange reserves. Hot money may be responsible for only half the pressure. Hence, they say, it cannot be a bubble. But history is full of examples of currency appreciation pressure building a bubble.
I am surprised that China is still running a trade surplus. The surplus is declining, but considering how depressed the world economy is and how hot China’s is, a trade deficit would be more likely. The surplus, I think, can be attributed more to distortions in domestic pricing than the currency’s cheapness.
He goes on to explain how price distortions he sees in the Chinese economy are suppressing domestic demand for goods and services, thus increasing the nation’s trade surplus. Thus the trade surplus may not necessarily be a sign of an undervalued yuan. He then goes on to describe what he sees as a bubble of yuan appreciation pressure.
I am not sure that yuan appreciation pressure is entirely a bubble. But a big chunk is. Instead of looking at appreciation pressure per se, it would be better to get rid of the hot money and clean up domestic price distortions. These should be the first steps. If yuan demand still exceeds supply afterward, the exchange rate should move.
Many analysts argue that raising interest rates would attract more hot money. This is wrong. Hot money comes to China for currency appreciation and asset bubble reasons, not to chase interest rates. When an interest rate is raised, expectations for property price appreciation wane and hot money is more likely to fall than rise.
And here he drops a bomb:
Increasing the yuan’s value a bit would certainly trigger more frenzy. Any new property booms that follow may support the economy for a time. But the long term consequences would be severe. Indeed, a small appreciation could make a crisis inevitable.
Thus there could be a yuan appreciation bubble, already formed and kept held tight by China’s yuan peg, since money has been flowing into China for years now in the hopes of the yuan’s appreciation. If the yuan is allowed to appreciate further, under the flawed notion that it is ‘undervalued’, this could only embolden yuan bulls to place even larger bets into the currency.
Interesting stuff… you have to admit that it’s now ‘common knowledge’ that the yuan is undervalued and will appreciate in the future. Just like it used to be ‘common knowledge’ that property never loses value and will always go up. It could be the largest bubble since the U.S. housing bubble that in retrospect will have seemed so obvious.
We’ve focused on what we found most interesting, read the full, broader Andy Xie piece here >
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