You could argue that America’s economy is hitched to the Chinese wagon. But it’s only true in the sense that Uncle Sam, the debtor, is trotting behind the Chinese bandwagon. Up to now, it’s been a leisurely trot, with a steady stream of cheap textiles and electronics coming off the back of the wagon. But yesterday, things changed. That is, the Chinese chose to remind the US that a debtor ought to be careful what he says to a creditor.
“China has accumulated a large sum of US dollars,” said He Fan, an official at China’s Academy for Social Sciences. He wasn’t exactly speaking for the government. But he was clearly articulating what’s on everyone’s mind. “Such a big sum,” he continued, “of which a considerable portion is in US Treasury bonds, contributes a great deal to maintaining the position of the dollar as a reserve currency.” But…?
“Russia, Switzerland, and several other countries have reduced their dollar holdings. China is unlikely to follow suit…as long as the yuan’s exchange rate is stable against the dollar. The Chinese Central bank will be forced to sell dollars once the yuan appreciated dramatically, which might lead to a mass depreciation of the dollar.”
Well then, there you have it. US Treasury Secretary Henry Paulson has pushed China to allow the yuan to appreciate, driven by nationalist and protectionist sentiments in the US Senate. China knows the US Congress is keen to act, and blame the foreigner in an election year for American economic woes. Its well-timed reminder of the leverage it has over the dollar is a warning to the Americans to be careful what they ask for.
And just what would a stronger yuan mean anyway? For one, it would mean marginally higher prices for Chinese imports in America. But would American textiles and manufactured goods suddenly become more cost competitive on global markets through a yuan revaluation? Maybe. Does America even make toaster ovens anymore?
For the rest of the world, Mr. Fan’s comments are a sign that a big transition lies ahead in the global economy. Imagine yourself as a member of the Chinese politburo. At what point does it make sense for you to allow your own currency to appreciate? Well, the whole point of having an artificially weak currency is to boost exports by keeping them cheap. China’s economic growth has thus far been export driven.
But today, China’s savers are pouring their money into a booming share market, risking both a stock market crash and the social instability it would create. Why not increase the purchasing power of those savings by allowing the currency to appreciate? This has the added benefit of containing local inflation, along with increased reserve requirements at banks and higher interest rates.
What’s more, increasing the purchasing power of the local currency means China’s economic growth becomes driven more by domestic demand instead of by exports to the American consumer. And after all, the American consumer is looking pretty bedraggled these days. His savings rates are low. His chief financial asset, his house, is at the centre of uncertainty. And his lines of credit are all but tapped out.
Yes, it sure looks like China has announced to America what it has known all along. Its investment in US Treasuries, and the support that offers both to the American dollar and the American consumer, were always driven by what was best for China. And what’s best for China now? Well, we don’t know for sure. But buying the US dollar doesn’t seem look a good idea for anyone right now. Selling it, on the other hand, or trading it for tangible assets…that seems like a much better idea.
On an entirely different note, what do you do when a stock goes up over 200% from your entry price? Well, normally you’d take your profits and count your lucky stars. It’s a good kind of “problem” to have. And it’s one we have with one of our alternative energy stocks at the Australian Small Cap Investigator. The little solar stock we like has consistently met its benchmarks and attracted some deep-pocketed investors. What’s next? More on that tomorrow…