Throughout my financial career I’ve found that in sizing up currency markets traders from the big banks have always been ten steps ahead of me.
I’ve hopefully learned to live with this–meaning that because I’m never going to outthink them I believe my best currency strategy should have two parts:
–to avoid making future currency movements a major element in constructing my portfolio, and
–to be a “fast follower” if I can–that is, to figure out from a trend change what the banks must be thinking and to consider getting on board if I think the trend is going to have legs.
China has moved the price at which it will buy and sell renminbi down by 1.9% yesterday and by another 1.6% today. Informed market speculation seems to be that another couple of downward moves of the same magnitude are in the offing.
From a domestic policy perspective, China would prefer a strong currency to a weaker one. As I mentioned yesterday, the country has run out of cheap labor and must, therefore, transition away from the highly polluting, cheap labor employing, export-oriented basic manufacturing that is the initial staple of any developing country. This kind of business has been the bread and butter of many Chinese companies, some of them state-owned, for decades. Many are resisting Beijing’s call to change. The strong currency is a club Beijing can use to beat them into submission. In this sense, the fact that the renminbi has appreciated by 10%+ against other developing countries’ currencies over the past year, and by around the same amount against the euro, China’s largest trading partner, is a good thing.
On the other hand, the developed world has made it clear to China that if it wants to be included in the club that sets world financial policy, and in particular if it wants the renminbi to be a world reserve currency, the renminbi cannot be rigidly controlled by Beijing. It must float, meaning trade more or less freely against other world currencies. So China has a long-term interest in doing what it has started to do yesterday–to allow the currency to move as market forces drive it.
Why now, though?
World stock markets seem to be thinking that a severe erosion of China’s GDP growth is behind the move toward a currency float–that it’s backsliding from a committment to structural reform.
I’m not so sure.
I think what currency traders have concluded is that Beijing has enough money to prop up its stock market and enough to keep its currency at the present overvalued level–but not both. So they’re borrowing renminbi and selling it in the government-controlled market in the hope of pushing down the currency and buying back at a lower price. Understanding what’s going on, and realizing the risks in defending a too-high currency level, Beijing is bending in the wind. Doing so limits the amount of money that can be made this way, effectively short-circuiting the strategy.
Offshore renminbi, which can’t be repatriated into China, trade about 5% cheaper that domestic renminbi. That’s where we should get the next indication of how far renminbi selling will go.
As far as my personal stock investing goes, my strong inclination is to bet that renminbi-related fears are way overblown. I’ like to see markets calm down a bit before I stick a toe in the water, though.