Consequences of a revaluation of the Yuan

[DAVOUT]

The currency of countries with a positive balance of their foreign trade is always accused to be undervalued; it could be true, but there is another explanation which can also be true, particularly in the case of China, it is the competitiveness which can be higher. I would not be surprised that the clothing industry be much more efficient in China than in the US; and China would not be exporting deflation (decrease in prices due to lack of demand) but efficiency (economical progress).

[Kidlicious]

Originally posted by DAVOUT
The currency of countries with a positive balance of their foreign trade is always accused to be undervalued; it could be true, but there is another explanation which can also be true, particularly in the case of China, it is the competitiveness which can be higher.

That's certain.

Originally posted by DAVOUT
I would not be surprised that the clothing industry be much more efficient in China than in the US; and China would not be exporting deflation (decrease in prices due to lack of demand) but efficiency (economical progress).

Deflation is described as falling prices that damage the economy. So lower prices from imports wouldn't be deflation unless they damaged the economy. That's debatable. Japan is definitely having trouble. Part of it is certainly due to cheap Chinese imports. The Japanese aren't big spenders, and when they save money on imports they don't normally go buy something else with their savings.

[MattyBoy]

Good timing, as I was just wondering about this last night. I was told that the Yuan is exchangeable with foreign currencies but the Renminbi is not. I would love to know how to find out more about China's restrictions on fx trading and share ownership by foreigners.

Presumably a fixed currency presents an arbitrage opportunity, because trading at anything other than the current consensus fair value favours one side of the trade over the other. A smart arbitrageur should be able to find a way of getting on the side of the USD-Yuan trading that is favoured by the unfairly priced exchange rate. Then they can just crank up the trading volume to increase their profits.

What am I missing?


As for the WTO, I recently read (in their explanatory documents) that they now strongly discourage restrictions on trade flows as well as fixed exchange rates.


One disadvantage of fixed rates not mentioned so far is that parties in the business of investing or trading via fixed exchange rates face an impossible modelling problem. This is because they have no indication of how the exchange rate is likely to change going forward. History suggests that the exchange rate will be exactly what it is now, but there is always a chance that it will have been revalued to a drastically different rate.

i.e: If you are committed to a future trade using a market-driven exchange rate, you can look at how volatile it has been to estimate its future behaviour. However, if you need to exchange Yuan for dollars at some point in future, the current flat exchange rate gives you no indication of what the future holds. Hence, under fixed exchange rates any change will wreck havoc on many investors, as they have been unable to effectively hedge their risks.

The above discussion covers volatility modelling under fixed exchange rates, but the same concerns also apply to correlations of fixed rates with other variables.

[yavoon]

seems like a good scheme. but didn't the japanese also try to keep their currency devalued as long as possible?

[Kidlicious]

Good points MattyBoy. I don't know how the Yuan trades or what strategies should be used. But I would be interested in finding out. It seems to me that traders would try to get a hold of all the Yuan they can since it is assumed to be undervalued.

edit: I guess there is a limit though. What if the currency never gets revalued, but eventually gets loses value. Still it seems like a good buy.

[Kidlicious]

Originally posted by yavoon
seems like a good scheme. but didn't the japanese also try to keep their currency devalued as long as possible?

The Yen probably is still undervalued. The BoJ has kept it basically pegged to the dollar for some months now. It stays at around 118-119 Yen/Dollar. They have good reason though with the deflation. Strong currency will make deflation worse.

[MattyBoy]

edit: I guess there is a limit though. What if the currency never gets revalued, but eventually gets loses value. Still it seems like a good buy.

I don't see how to take much advantage of a static mispricing without importing or exporting. But if relative interest rates on either side of an exchange are mismatched with the currency futures, you can arbitrage one against the other in any quantity you want. e.g: if the Yuan should be drifting, but it is fixed, bring on the profits.

Come to think of it, what I am doing posting when I could be arbitraging?

Gotta go!

[mindseye]

I was told that the Yuan is exchangeable with foreign currencies but the Renminbi is not. (...) What am I missing?

You are missing the fact that the yuan and the renminbi are the same thing.

[DAVOUT]

For the first two months of 2003, the foreign trade balance was negative by 600 millions$. Another argument for the Chinese not to revaluate ...

http://www.pbc.gov.cn/english/hanglingdaojianghua/

[Kidlicious]

Originally posted by MattyBoy

I don't see how to take much advantage of a static mispricing without importing or exporting.

If they revalue you could then sell for a profit.

Originally posted by MattyBoy
But if relative interest rates on either side of an exchange are mismatched with the currency futures, you can arbitrage one against the other in any quantity you want. e.g: if the Yuan should be drifting, but it is fixed, bring on the profits.

Come to think of it, what I am doing posting when I could be arbitraging?

Gotta go!

But the Yuan isn't drifting. It sells very close to the pegged price. As soon as the price goes up the BoC sells more, right? If the price were to go down they would buy them back.

[Q Classic]

if the yuan gets devalued, it'll be good for them, but bad for everyone else in the region.

devaluing their currencie allows their exports to be even cheaper... which is why japan and korea did it so long.

having china do the same thing would exert yet another avenue of pressure in the already cutthroat competitive atmosphere between the region's economies.

[Kidlicious]

There is talk of revaluing to make it stronger

[DAVOUT]

Originally posted by mindseye

I was told that the Yuan is exchangeable with foreign currencies but the Renminbi is not. (...) What am I missing?

You are missing the fact that the yuan and the renminbi are the same thing.

The law creating the People s Bank of China (Central Bank) gives the definitions :

Chapter ‡V The Renminbi @@

Article 15 The legal tender of The People's Republic of China is the Reminbi(RMB).When the Renminbi is used to repay all public or private debts within the territory of the People's Republic of China, no units or individuals may refuse to@accept it.
Article 16 The unit of the Renminbi is the yuan and the units of the fractional currency of the Renminbi are the jiao and the fen.

[Lawrence of Arabia]

Devaluation is stupid for the country. First of all, China needs to regulate who gets can export because if it didn't, they would run out of cash. Secondly, it doesn't ajust to changes in the trade balance. With a floating or a dirty floating currency, when exports increase, the currency gains value, which in turn decreases exports. When imports increase, the currency loses value, which decreases imports. It regulates itself.

[Tingkai]

Re: Consequences of a revaluation of the Yuan

Davout: you ask some good questions, and got some really bad answers. So me try to give some decent answers. It's 1am in HK so I won't cover everything.

The first thing is you were right when about this.

Originally posted by DAVOUT
Chinese exporters billing in dollars receive dollars that they change against Yuans through the BoC at the fixed rate of 8.28 Yuans for 1 $.

The rmb (same thing as yuan) can essentially only be changed through the BOC. There is NO open market trading of the rmb (what Kidacious said is wrong)

Let's say you take some products into China and sell them and get 100,000 rmb. Chinese law requires you to go through the BoC to change the money into US$. You cannot wire the money out of China because no one will do it because it is illegal.

You won't take the actual cash out because customs will confiscate if you try and besides what are you going to do with RMBs in the US.

If you want to sell the rmbs on the black market. You say to someone, I'll pay 6 rmb for your US$1. The guy with the US money will say forget it, because he can go to the Boc and get 8.28 rmb for his US$1.

If I have US$ and you say to someone, give me 10 rmb and I'll give you US$1, the guy will say forget it because he can buy the US$1 for 8.28 rmb (of course there will be minor service charges for exchanging the money).

Your next statement is wrong.

Originally posted by DAVOUT
The BoC, once it has covered its need in cash $ and provided for the payments of foreign investments or reimbursement of previous loans, has now an assets with no yield.

Currencies have a yield. About a year ago, if I had US$100, I could have changed into 100 euros. Now, a year later, the exchange rate has changed. I can take that 100 euros and change it into US$112. I have now made a profit of US$12.

It is highly likely that China has done this. An important thing to remember is that China's foreign reserves are not in US$, the reserves are valued. China likely had billions of euros (we don't really know because the exact holdings are state secret). As the value of the euro increased, China would have sold the euros for US$ thereby increasing the US$ value of its reserves.

Alternatively, a year ago, as the euro rose against the US$, China may have sold its US$ holdings on the belief that the Euro would continue to strengthen. This would have pushed the US$ value down. China can now sell the euros at a profit, but of course this can't continue forever because by selling euros for US$, China helps push of the value of the US$.

Originally posted by DAVOUT
Now, lets assume that they accept to revaluate the Yuan by 20% (6.62Yuans for 1 $). The Chinese exporters billing in $ will quickly increase their prices in order to get the same amount of Yuans than before;

Maybe yes, maybe no, depends on how you look at it.

Let's say a Chinese company is selling widgets to an American company at a price of US$1 (which equals 8.28rmb). Then the rmb is revalued at 6.62 rmb=US$1. The Chinese business may try to raise his US$ price so that he still gets 8.28 rmb. In this case, his US$ price has increased, but his rmb price, and the volume of his sales in rmb, is still the same.

It is possible that the US buyer is willing to accept the higher US price in which case there is no change in the foreign trade balance, but it is probably more likely that you are correct in saying.

Originally posted by DAVOUT
this will causes a decrease in the volume of sales which will reduce the positive foreign trade balance, and the amount of dollars (converted in bonds) monthly accumulating in the coffers of the BoC.
Correlatively, this effect will be partly offset by the decrease in price of imported goods billed in dollars.

Originally posted by DAVOUT
One step further, the reduction of the cost of imported goods will be partly reflected in the cost of exported goods then in their price in $, the increase of which being finally smaller than the revaluation. We see that a revaluation does not suffice to revert the trend of a currency to be reinforced by a consistent positive trade balance.

No, you're assuming a market in which there are only US buyers and Chinese sellers.

Let's say producing widgets in China costs $7.50 rmb and the widgets sell for U$1. The Chinese company is making a profit (US$1 exchanged into 8.28 rmb is a profit of .78 rmb.

Then the rmb appreciates by 20%. I don't want to do the math, so let's just say the Chinese firm now needs to charge US$1.10 just to cover his costs. But a company in Thailand is willing to sell widgets for US$1.05. The Chinese company can't match that price because the company would be selling at a loss. So the Thai company gets the contract.

It is possible that Chinese companies lose so many contracts that exports drop that China ends up in a trade deficit.

Originally posted by DAVOUT
There are two possibilities to stop the increasing stockpile of foreign currency held by the BoC : one is to make foreign investments (not bonds), but there is so much to do in China that we cannot imagine a foreign investment policy launched by the Chinese anytime soon;

No, if China has US$1 billion in foreign reserves, that money can only be invested outside of China. The government can't pay workers US$ because the workers will simply go to the BoC and change it back into RMB and the BoC ends up with US$ again.

Although you are correct that the Chinese government could buy foreign machinery and bring it into China, which would be an internal investment.

The BoC may also be buying US stocks, but is more likely taking a conservative approach of buying US bonds.

Originally posted by DAVOUT
Overall, it is easy to understand that the Chinese government is not in a hurry to modify anything to the current situation which lets open all possibilities.

Yes, and the big thing is that a re-evaluation could price Chinese companies out of the international market.