Yuan Denominated Assets
We sell to China a lot more than they buy from us (the US for our foreign readers). They finance a lot of our debt. Hence they hold a lot of US dollars.
They are, therefore, rationally concerned about how much money we are printing to deal with our economic problems. And we in turn are also rationally concerned about how they artificially peg the value of the yuan against the dollar at a low rate so they can continue to sell us so many goods.
Just about every expert agrees if the yuan were allowed to float more freely against the dollar in a traditional market, supply and demand sense, it would appreciate. Indeed, appreciate greatly.
Whether it will occur that way or in a more managed, regulated sense, the writing on the wall seems clear: The yuan is going to appreciate against the dollar.
If that’s so, then how is it not close to a sure thing (given there is no sure thing) for American investors to invest in yuan denominated assets like this one. Your investment will appreciate once the yuan does along with it.
For folks who know more about finance than I do, 1) where am I going wrong, and 2) what other yuan denominated assets exist for middle class folks to invest in?
Possibilities:
1. Efficient markets (i). The appreciation is already baked in. Plausible because of the very low yield on the bond, which basically means the Yuan has to appreciate for this bond to be a good investment.
2. Efficient markets (ii). The appreciation is already baked in, as is the risk of political instability in China, which is now deemed greater than the risk of political instability in the United States. Given that North Korea sits right on their border, this seems at least plausible to me. A messy North Korean collapse could be a big, big problem for China.
3. Fears of corruption and the lack of financial transparency in China make the investment relatively unattractive. The construction industry as I understand it is particularly corrupt.
4. Property rights in land and capital are still very shaky in China. So while China Telecom has done well, it’s also already a partially state-owned business, and the state won’t kill the goose that lays the golden eggs. A foreign construction firm? Those geese are yummy!Report
Thanks!Report
The other possibility is that the China’s domestic money supply rises to the level consistent with the Yuan’s external exchange rate, which would almost certainly create horrendous inflation. There are signs of inflation already, so this isn’t completely impossible, although China does try to prevent the extra Yuan from entering the domestic economy.Report
China owns 4% of our national debt and its banks are quickly losing interest in buying more of it. It is a myth that our debt is financed by China; we are financing our own debt for the most part and for the 20% we are looking abroad for, we look to the UK and Japan before we look to the PRC.
Now, that doesn’t mean I think our debt nothing to worry about, it doesn’t mean I think the artificially-weak renminbi is desirable, and it doesn’t mean that I think Jon’s larger point is off base (the renminbi is unsustainably weak). What I’m really wondering, though, is why we aren’t investing in Chinese capital with our relatively strong dollars, so when the currencies stabilize, we don’t wind up owning more of the renminbi flow and recapturing those profits?Report
“What I’m really wondering, though, is why we aren’t investing in Chinese capital …?
I wonder what the restrictions are that the Chinese govt. places on foreign investors inside China’s borders.Report
It’s a very mixed situation, as I can tell you based on my experience in working with several parties that operate on the mainland from outside of the country. For instance, the government is more than happy to accommodate all manner of enterprises, though there are indeed restrictions. For instance, if you want to open chain restaurant locations, there must already be at least two existing locations elsewhere in the world. I’m not sure why this is. At any rate, the Chinese government has wisely provided an environment that is attractive to investors lest their thunder be stolen by such nations as Vietnam which have also managed to lure in a great deal of capital lately.Report
China has a closed capital account, and exchange controls, meaning its hard for foreigners to buy enough renmimbi to invest in anything much, and hard for them to then actually invest them. State permission is required for both steps. I suppose there’s nothing to stop a EuroYuan market in RMB denominated assets from appearing in free-er markets like Hong Kong or even the US, like that caterpillar bond, but it seems unlikely there’s enough Yuan outside China to support it.Report
Bingo.
This is the correct explanation. Unless you are purchasing physical assets in China, you cannot actually invest there. The Chinese stock exchange and bond markets are closed to foreigners.Report
Simon hits upon the problem IMO. China may let you buy a bond that pays Yuan but when it does they won’t let you take the Yuan out of China. That’s great if you want to live in China I suppose but if you’re just looking for something for your 401K you’re out of luck.Report
Interesting. Is that trend among South East Asian nations that embrace the sort of nascent capitalism that’s far more authoritarian/less democratic than the Western style. I seem to remember, years ago Noam Chomsky harping on a similar angle explaining why the Asian tigers really weren’t international capitalist success stories. He cited their capital controls as reasons WHY they are successful.Report
There’s a classic monetary trilemna that goes like this: open captal account, fixed exchange rate, control of domestic monetary policy. Pick any two. If you have a fixed exchange rate and an open capital account, you lose control of the money supply because you’re obliged to issue currency to foreigners to keep your exchange peg so money rushes in and out of your country causing uncontrollable inflation and deflation. Most governments consider this unacceptable for obvious reasons, although it has been tried by small, highly credible economies like Hong Kong where people are very unlikely to suddenly decide to yank all their money out. If you have a fixed exchange rate and want to control monetary policy, you have to close the capital account to prevent the extra currency issued on the international market from entering the domestic economy. This is what China is doing. If you forgo the fixed exchange rate, you can allow free foreign investment and control your money supply, but a floating exchange rate in a small economy can lead to huge influxes and outflows of foreign capital and this can be destabilisaing in itself. This is the regime the IMF tried to persuade lots of developing countries to adopt after Bretton Woods failed and everyone’s currencies became unpegged.
To my knowledge though, no country ever succeeded in adopting the IMF model for very long, which is why the IMF has now basically changed its mind. While the West was developing we were all on the gold standard, and it wasn’t generally possible to do much in the way of cross border investment, except in certain special cases like Britain and the US, so there was some freedom to control the supply of notes and bank deposits even though everyone remained on gold. This is in essence what China is doing. I’m not sure what’s “not capitalist” about it. Chomsky probably thinks the old IMF model is “imperialist” since it allows foreign investors potentially very high levels of investment. As usual Chomsky is confused – the problem isn’t that foreign investors have too much control, its that they leave too easily.Report
Thanks for this. As a global capitalist (and a professor of international business), I’m interested in this passage of your reply:
“but a floating exchange rate in a small economy can lead to huge influxes and outflows of foreign capital and this can be destabilisaing in itself. This is the regime the IMF tried to persuade lots of developing countries to adopt after Bretton Woods failed and everyone’s currencies became unpegged.
“To my knowledge though, no country ever succeeded in adopting the IMF model for very long, which is why the IMF has now basically changed its mind.”
I know that the currencies of the 1st world nations tend to float against one another in the Forex market. Not as laissez faire as some would like but, for the most part, guided by supply and demand (and governments tinkering with thereof in a variety of ways). The 2nd and 3rd world nations have more of a tendency to peg, to use currency baskets and so on. And their pegging almost always has some kind of market distorting ulterior motive to it; i.e., keep the currency low so they buy more of our goods or keep it higher than it normally would or else our currency would be worthless.
What’s the problem with lesser developed nations permitting their currency to float and printing money according to a Milton Friedman like plan where you print according to your projected growth and needs so you don’t overly inflate your currency?Report
Well thinking it thru say your little country would have no control over its exchange rate but given that exports are probably a very important part of its economy radically shifting exchange rates will cause your economy to go up and down. Since growth isn’t stable your Friedmanish rules for money printing in a steady manner would no longer make sense. On top of this your small country is probably going to have plenty of companies and individuals who will want to borrow money and since international capital markets tend to use the big currencies like the dollar, yen and Euro they will incur debts denominated in those rather than your local currency which you control.
The problem then would possibly come when your country suddenly looks ‘hot’ to the ‘digital herd’. Money rushes in and your currency goes up. Debts in the big currencies accumulate. The ‘digital herd’ suddenly changes its mind because, say, they loose money on Russian debt….now your currency starts to fall. Normally this would be offset by exporters increasing their sales but their debts aren’t in your falling currency but hard dollars or Euros or Yen….bankruptcies increase and successful businesses can’t get access to capital. In the meanwhile your central banker scratches his head and wonders how it could all go wrong when he was following the simple Friedman rule of just modestly increasing the money supply a bit each year.Report
A fluctuating exchange rate causes variation in the prices of imports and exports, so the attractiveness of particular investments varies with the exchange rate. If my currency is expensive, I can afford to import a lot of inputs, but local labor is expensive by world standards so I don’t want to use much of it, so I should probably invest in lots of labor saving capital and make things with costly raw materials. eg. I should be like Taiwan or Hong Kong. If my currency is cheap, I can’t to import lots of inputs, but my labour looks very attractive, so any industry that needs a lot of labour and where the inputs can be sourced internally looks attractive.
That’s fine for a developed economy because our exchange rates tend to stay fairly stable, and the vast majority of currency exchanges are being used to pay for goods and services across borders. Most capital investment happens within namtional economies and isn’t very sensitive to exchange rates. If people buy a lot of your stuff, your currency appreciates. If you buy a lot of stuff, it depreciates. So things end up in equilibrium
But for a small economy with an open capital account, the exchange rate can fluctuate wildly with the sentiments of international financial markets. A few hedge fund managers deciding your country is the latest thing can push your exchange rate sky high and bankrupt domestic businesses that now can’t afford to keep their outputs competitive. But a downgrade or a banking crisis can send money speeding out of the country and push the exchange rate through the floor, and then domestic producers can’t afford their imported inputs any more.
This is a double bind. Its really hard for domestic investors to get a return because they don’t know what to invest in, but its exchange rates won’t stabilize without the mass of a serious amount of domestic capital to stabilise the capital markets, and that won’t happen unless domestic investors can get a return.Report
http://www.marketskeptics.com/2009/09/china-hoarding-gold-and-plans-to-issue.html has an article about China issuing Yuan denominated bonds in Hong Kong. Problem, 6 Billion Yuan is something like 900 million US dollars. Most small US states have more outstanding bonds than that.
Some googling seems to indicate that you can’t buy Chinese stocks or bonds or even currency that easily unless you plan to live in China. You can buy mutual funds and EFTs that seem to trade in Chinese stocks and currency but you’re not actually buying Chinese currency. http://seekingalpha.com/article/211162-chinese-currency-etfs-waking-up-to-a-yuan-yawner?source=qp_investment_views For example, notes that Yuan EFTs are buying currency futures, not physical currency. Despite a modest rise in the Yuan the funds are saddled with high expenses.
I suspect one reason why it’s not so easy to find Chinese bonds is simply because the gov’t doesn’t need to issue them. The Chinese have very high savings rates which reflects the fact that they have little safety net and the gov’t frustrates the ability of the Chinese consumer to consume by keeping the currency expensive. That massive amount of savings is put in Chinese banks for whom the gov’t has a massive amount of input into their lending decisions.Report