Consequences of a revaluation of the Yuan

[Kidlicious]

Originally posted by Tingkai
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$, China helps push of the value of the US$.

Thanx for the info we were missing.

You are wrong on the account of the BoC stockpiling Euros though in exchange for dollars. If the BoC were to sell dollars they would weaken the dollar. Since the Yuan is pegged to the dollar they would simply have to buy those dollars back to keep the peg.

It is natural for China to have a large reserve of dollars because of the positive trade ballance with the US. The last thing that China wants is for the dollar to fall any more than it already is because it would decrease the value of their reserves. The BoC is not interested in selling dollars, I assure you that.

[MattyBoy]

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.

Thanks, Tingkai. This was the kind of information I was hoping to find out. It is obvious how a fixed rate fails to work in an open market, but I am interested to learn more about how the fixed rate + exchange controls approach works.

[Kidlicious]

I'm still unclear on how the Chinese buy dollars. With Yuan? Then isn't the Yuan traded externally?

[DAVOUT]

Originally posted by Kidicious
I'm still unclear on how the Chinese buy dollars. With Yuan? Then isn't the Yuan traded externally?

They certainly dont want to create an external market for the Yuan, but through their foreign trade they receive $ AND Yens. Selling Yens against $ is a possibility.

[DAVOUT]

The subject is becoming hot on the Hill !

http://www.reuters.com/newsArticle.jhtml;jsessionid=UMNGHAYQI4F2ICRBAEZSFEY?type=reutersEd ge&storyID=3198715

[Tingkai]

Originally posted by MattyBoy
Thanks, Tingkai. This was the kind of information I was hoping to find out. It is obvious how a fixed rate fails to work in an open market, but I am interested to learn more about how the fixed rate + exchange controls approach works.

The short answer is, if you want to sell or buy lots of RMB, you have to have the paperwork to explain why you are doing it. You can't walk into a BoC bank and say "Here's US$100,000, I'd like to have 880,000 rmb."

Importers/Exporters need to have paperwork explaining their need for currency exchange.

Mainland Chinese are only allowed to carry out X amount of rmb when they travel abroad.

When a foriegn company sets up shop on the Mainland, there are rules about how much money they can take out.

Mainland companies operating overseas have been told to repatriate all of their capital reserves held overseas.

The regulations constantly change so the above are just general ways that the Chinese government controls its currency.

[mindseye]

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

Within China the terms renminbi and yuan are used interchangeably (along with kuai here in Shanghai).

[Tingkai]

Originally posted by Kidicious
You are wrong on the account of the BoC stockpiling Euros though in exchange for dollars. If the BoC were to sell dollars they would weaken the dollar. Since the Yuan is pegged to the dollar they would simply have to buy those dollars back to keep the peg.

You're still assuming that the rmb is freely traded, which it is not. Because it is not freely traded, the Chinese government does not need to buy US$ to keep the peg.

Before you start going about how I am wrong, how about you give a full explanation about your statement above.

Originally posted by Kidicious
The last thing that China wants is for the dollar to fall any more than it already is because it would decrease the value of their reserves. The BoC is not interested in selling dollars, I assure you that.

No. Let's say China's foreign reserves consist of US$1,000 and 100 euros. If the exchange rate is US$1=1 euro then China has a foreign reserve valued at US$1,100.

If US$ falls and the exchange rate becomes US$1=1.10 euros then China's foreign reserve is now US$1,110 (US$1,000 plus the 100 euros that are worth US$110).

So any fall in the value of the US dollar increases the value of China's foreign exchange if that value is stated in US$ terms, which it traditionally is.

Furthermore, if China perceives the US dollar as being weak and unstable, then it will want to switch to the stronger euro. If it ever needs US dollars then it can buy them at a later date, and a cheaper rate (assuming the US$ continues to fall relative to the euro).

So China very much has an incentive to switch its foreign reserves from US dollars to euros or any other strong currency or asset (eg, gold, stocks, Canadian government bonds, whatever).

[DAVOUT]

Tingkai,

I desagree with your definition of a yield for the currencies. What you describe is a speculation which can work or not. Central Banks do not speculate with the reserves, but they are interested in having them producing a small income without risk; it is the reason why many central banks sold their gold, a couple of years ago, against US$ ultimately converted in US bonds. The BoC had a very small amount of gold (578.7 tons) representing less than 2% of their total reserves at the end of 2002, demonstrating their preference for reserve producing no risk income.

When central banks are shifting their reserves from one currency to another, it is for policy reasons, with long term views, not for cashing a windfall profit.

[Saras]

Originally posted by DAVOUT
Tingkai,

I desagree with your definition of a yield for the currencies. What you describe is a speculation which can work or not.

Exactly. Yield is something you get for credit and interest rate, not FX risk.

[DAVOUT]

Tingkai,

I am not assuming a market in which there are only US buyers and Chinese sellers, and the reduction of the Chinese positive balance that I anticipated in my post is obviously due to the turnover lost by the Chineses and won by the competition. And the Chineses buyers will enjoy the reduction of their costs for all their purchases coming from all countries.

Regarding the investments in foreign countries, I was not referring to the Chinese government paying US workers of course, but to private Chinese companies authorized to build factories abroad. Even if not likely in an immediate future, THIS can be contemplated as a way to reduce the stockpile of US $.

[Tingkai]

Originally posted by DAVOUT
Tingkai,

I desagree with your definition of a yield for the currencies. What you describe is a speculation which can work or not. Central Banks do not speculate with the reserves, but they are interested in having them producing a small income without risk; it is the reason why many central banks sold their gold, a couple of years ago, against US$ ultimately converted in US bonds. The BoC had a very small amount of gold (578.7 tons) representing less than 2% of their total reserves at the end of 2002, demonstrating their preference for reserve producing no risk income.

When central banks are shifting their reserves from one currency to another, it is for policy reasons, with long term views, not for cashing a windfall profit.

I agree that Central Banks are conservative investors, but I disagree that they do not speculate, or at least not the ones in Asia. Information about what the BoC does is limited, but look at the Hong Kong Monetary Authority. They are very conservative investors, but they do seek to make money on the reserves.

"The Annual Report contains the audited Exchange Fund accounts for 2002. The investment return on the Fund in 2002 was 5.1%, which was 120 basis points higher than the return on the benchmark set for the Fund by the Exchange Fund Advisory Committee." -- HKMA 2002 annual report.

The exchange fund is the Hong Kong government's foreign reserves (edit: to be more specific, this is the money that backs the HK$) , plus fiscal reserves.

Singapore does the same thing with its fund managers earning US$1 million a year (the Singapore government argues managers are paid well because they make good investment choices.

Do they speculate on Fx, officially no for political reasons, but if you are the head of the BoC last year, what would you do? The conservative approach would be to switch from dollars (which were at high risk of losing value) to euros which were safer. Now that euro is strong, the conservative choice would be to switch back to US$. You can call that a windfall profit, but I would call it wise investing.

[Tingkai]

Davout: you seem to know about this topic. Do you have any information about the foriegn currency holdings of the BoC?

[DAVOUT]

Originally posted by Tingkai
Davout: you seem to know about this topic. Do you have any information about the foriegn currency holdings of the BoC?

- About this topic I know not enough, but I try
- The holdings as you said are reported in US $ by the BoC (except gold), but the foreign exchange transactions in US$ amount to 98% of the total, the remaining being shared about equally between HKD and JPY (and € 0.1%). That is not enough to build huge stockpiles of € or JPY without serious arbitraging against the US$.

[Kidlicious]

Originally posted by Tingkai
You're still assuming that the rmb is freely traded, which it is not. Because it is not freely traded, the Chinese government does not need to buy US$ to keep the peg.

You can't peg a currency by regulating how it is traded within your own country. The regulations only matter in China. You have to trade currencies to keep a peg. China has a positive trade balance with the US which makes the Yuan stronger than the dollar. In order to keep the peg they have to trade Yuan for dollars. It's possible that they use Yen or something else to buy the dollars, but they certainly have to buy dollars. And if they don't use their own currency it is more expensive for them. By buying dollars with Yen you weaken the dollar but if you compare that with buying dollars with Yuan the first method is more expensive because you have to spend more Yen than you would Yuan to get the same effect.

Originally posted by Tingkai
Before you start going about how I am wrong, how about you give a full explanation about your statement above.

I think that you understand what I'm saying, but you just don't see that the BoC does have to buy dollars. If you don't believe that there isn't much else to say.