When Secretary Paulson arrives in Beijing this week, a major topic of discussion will be currency policy. The Yuan has risen over 20% since the Chinese government allowed it to float in 2005, but in recent weeks the “Trend” has come under pressure. Friday’s decline of 0.7% to 6.8848 USD was the largest single day drop since the fixed exchange rate ended in 2005. Chinese rhetoric changed last week. They, like us, feel they have the right to let their currency depreciate in order to stimulate export growth.
“Hank the Tank” has been exceedingly diplomatic with Chinese leaders about currency manipulation throughout his tenure and in this final major financial summit between the two nations before the inauguration it is doubtful that he will change his tone in the final stretch. Hank “The Market Tank” is going to march into China and tell them to let their currency appreciate. The Chinese will smile and hear, but we highly doubt they listen.
For now the data continues to support a weaker Yuan, whether with the tacit approval of the government or not. PMI declined to 40.9 in November from 45.2 in October according to the CLSA survey released today, the largest one month decline since the survey started in 2004 (a separate survey run by NBS had comparable figures). As exports continue to cool, the Chinese case for a weaker Yuan (to sustain growth) is bolstered by massive state holdings in USD denominated assets: the amount held directly in US treasuries alone now exceeds 10% of GDP.
We are long the Chinese market via FXI; regardless of long term currency policy, we believe that in the near-term the equity market there will feel the benefits of strong government stimulus policies, competitive dominance in manufacturing and sustainable domestic demand growth.