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[TTHQ Staff]

BEING STREET SMART
___________________

Sy Harding


CAN RENMINBI-YUANS FLOAT? July 15, 2005.
Evidence late this week is that the world may find out in August.

Ever since China began emerging as an economic power more than a decade ago, it has kept its currency, the renminbi-yuan, pegged in value to the U.S. dollar. The result has been that as China’s modernization and manufacturing prowess have made impressive advances, the U.S. has been powerless to halt its growing trade deficit with China.

The U.S. has employed its traditional weapon for correcting trade deficits, which is to have the dollar decline against other currencies. That makes U.S. products less expensive for consumers in other countries, while raising the prices of foreign goods coming into the U.S.

This time around it has not come close to working. In spite of a 30% decline in the U.S. Dollar Index over the last three years, the U.S. international trade deficit has continued to soar to new records, now running around $55 billion a month ($660 billion a year). China’s portion of that deficit, grew to $167 billion in 2004, and is now running at an annualized rate of $195 billion in 2005.

The U.S., and much of the rest of the industrialized world, have been pressuring China for several years to abolish the peg of its currency to the dollar, and allow it to ‘float’ freely in currency markets, where the market would set its value. While that would not solve the entire U.S. trade deficit, it is thought that it would at least decrease the trade deficit with China.

So far China has resisted, stating that it will allow its currency to float when that is advisable for its own well-being, and not due to pressure from other countries. That China would be reluctant to decouple its currency from the dollar is understandable. Economists estimate the renminbi-yuan would surge as much as 30% in value against the dollar, and to a lesser degree against other international currencies, resulting in a serious blow to China’s export economy, creating a recession, a financial crises for its already struggling banks, unemployment, and all kinds of other bad things.

However, over the last year or two China has obviously become aware that allowing its currency to float is inevitable, and has been hinting that it will move in that direction.

Tired of waiting, Congress is considering a bill to impose a 27.5% tariff on Chinese imports. It’s a bill the White House does not want, since it would cause problems as the U.S. strives to spread the gospel of democracy and free markets to the world.

However, the London Financial Times reported on Friday that the Bush Administration has told key senators that it expects China to revalue its currency in August, ahead of a planned visit to Washington by Chinese President Hu Jintao in September, and that the senators, co-sponsors of the tariff bill, agreed to delay a vote on the bill on that assurance.

I have not yet seen confirmation in U.S. financial or political news. But if true, debate will surge again as to what revaluation of China’s currency might mean for the dollar, stocks, bonds, and gold. Hedge funds will have a field day betting on whatever might be their various expectations.

U.S. producers of manufactured goods and textiles are in favor of China allowing its currency to revalue higher, as they would hopefully be better able to compete against Chinese manufacturers. However, large U.S. discount retailers, as well as aerospace companies, computer and other high-tech manufacturers, which depend on Chinese factories to supply inexpensive products and components, are not in favor.

The consequences would be complicated, not as simple and positive as it would seem on the surface to have Chinese goods be more expensive in the world. The laws of unintended consequences may take part.

For instance, many economists believe that making the dollar less valuable against the rinminbi-yuan would cause the Chinese government to buy fewer U.S. treasury bonds and sell some of its current huge portfolio of U.S. bonds, causing bond yields to rise and bond prices to fall, U.S. interest rates to spike up, and the U.S. economy to suffer. (Thanks to its surging export economy, China’s stockpile of foreign currency reserves have also surged, currently nearing $800 billion, and with its currency pegged to the dollar, those reserves have been primarily in U.S. treasury bills and bonds.).

However, one thing you can bet on. The Chinese are not dumb.

China will not make the move to floating its currency in one sudden jump. The U.S. has long since scaled back its demand for a full float, which would result in probably a 30% revaluation, to hopes for a 10% revaluation. I doubt even that big a step as an initial move.

More likely would be a system that would remove the currency’s peg to the dollar, but replace it with a peg to a basket of currencies, with China controlling, perhaps not even revealing, how each currency is weighted within the basket. That would allow China to begin with its currency still pegged mostly to the dollar, and gradually change the weighting within the basket, perhaps over years, thus avoiding any sudden economic disruptions in China, the U.S., or in currency markets.

But, unless such a measured pace is revealed ahead of time, once it appears that a move on its currency by China is imminent, hedge funds and speculators may produce considerable up and down volatility in a number of markets.



Sy Harding is president of Asset Management Research Corp., DeLand, FL, publisher of The Street Smart Report Online at www.streetsmartreport.com and author of 1999’s Riding The Bear – How To Prosper In the Coming Bear Market.