Would 6RMB/ USD Be A Good Thing?: Part 1

Thursday, November 1, 2007 9:23

Other than product safety, there have only been a few topics of discussions surrounding China’s relationship with the world that have made it longer than the discussion of the RMB. It is a topic I have covered several times in previous posts, and it is a topic that we are currently fielding votes on (that is your hint to vote now).

The RMB in my view is what I would call a political lightening rod. It is not as hot, nor does it cut as close to home as this summer’s product recalls… but various politicians have done an excellent job of tying the RMB to trade.. and trade to jobs.. and that has hit a bone with many who feel that China has unfairly valued its RMB.

For this post though, I am not going to look at whether or not it is unfairly valued, nor will I look into the issues surrounding the politics of the RMB. Instead, I am going to focus on the what it… as in what if the RMB went from the current 7.45RMB = 1USD to ….say 6RMB = 1 USD (a nearly 20% revaluation). Now I know.. that is only half of what the politicians in Washington have said needs to happen, but 6 RMB is a start, and you have to start somewhere.

So.. the RMB goes to 6. What next?

Well… in my mind, here are a few of the things that need to be considered (by all means, feel free to add on… as I am sure I will miss something).

First, over the last 8-10 years, it has been the Chinese who have been buying US denominated debt instruments (namely Tbills). they have been doing so as the U.S. spends more and more (war + imports), and the Chinese banks have accumulated a large amount of these bills. now, if the RMB would go to 6RMB/ USD, these banks would essentially take a bath in the order of 20%. Who cares right? Wrong… after all.. who else is going to buy these things?

So, to entice new buyers, the US will then have to make a move of its own to make these bonds more attractive to foreign investors, and that means that interest rates will have to come up. After all, price and interest rates have a reverse relationship, and for investors to be interested in investing in anything, the price to return must be in their favor. Well… if you have just hammered your largest buyer, you are going to have to seduce our next one.. and for the Fed that means higher interest rates.

Further down the chain, that means that the US consumer is going to see higher rates on their mortgage, credit card, student loans, car loans, etc… and for an economy that has already see more bankruptcies and foreclosures than ever before because of poor credit management, this is not going to be a good thing. Worst case is that more people are pushed over the edge as their payments go up… but I think we can all agree that as everyone’s payments go up, spending will come down.. and thus the US economy may actually see some downside.

In the industrial side, the side that most politicians say is being outsourced to China for the cheap.. those Chinese goods just got a lot more expensive. 20% more expensive.. and that will be a double whammy for consumers whose credit card bills just went up from the interest rate hike and importers who will be without an alternative to China.

See… one of the things that congress fails to mention is that while “China depends on us more than the US depends on it”, and immediate actions could risk the supply chain of just about everything purchased in the United States. this is not to say that everything is made in China, but think about the fact that the majority of products on shelves today have at least 1 component from China… and if the manufacturer of this commodity needs to go and find a new source, it is going to take them a long time to do so. AFter all, it is not like their U.S. suppliers have just been waiting for them to come back like a house pet. they too have probably offshored as well, or are at the very minimum exposed.. and that means that a quick revaluation may result in stock outs.

Either that or the entire 20% gets passed onto the consumer… the same consumer who is now paying more to banks for their goods…

Now, I do apologize for this oversimplification, but with the House and Senate currently considering punitive legislation, I felt the need to type something up. I have no doubt that this will be an issue we revisit as the 2008 election heats up, and I can only hope that cool heads will prevail.

To learn more about the effect the RMB has on trade, some alternative measures that would actually have a positive impact, or to view the current bills under consideration, please see the resources below:

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6 Responses to “Would 6RMB/ USD Be A Good Thing?: Part 1”

  1. Boyd R. Jones says:

    November 4th, 2007 at 10:19 pm

    It would be interesting though to know what the current analyst consensus is (if any) in terms of how high the RMB will go in the next few years. Any idea?

  2. Rich says:

    November 4th, 2007 at 10:49 pm

    Hi Boyd,

    I have done a fair bit of reading on this, and I have yet to see a common consensus. Is the 6 ~ 7 RMB range a possibility, sure. but whether it is in the upper 6, lower 6, or other is anyone’s educated guess.

    My personal opinion is that once the RMB fully floats, it will go the other way as people move to a hard currency. there are a lot of people in the mainland that remember losing everything, and I think they will look to protect themselves.

    Either way, everyone is betting against that idea (perhaps I am betting against them) by buying assets in China. the clear trend in the short term is clear… stronger RMB/ weaker USD.

    R

  3. Josh says:

    November 7th, 2007 at 2:18 am

    The real issue is not whether it ‘should’ be higher or lower, but rather what the markets dictate. A good is only worth what someone will pay for it, so why should currency be different?

    The biggest fear would be setting off a currency crisis which would cripple the economy much as it did to Korea and Thailand in the late 90s. Ironically the world community told China to devalue their currency at that point, which they wisely refused to do. For a country with some iffy policies, their currency plan (was it really a plan) has proved highly stabilizing.

  4. Rich says:

    November 7th, 2007 at 6:50 am

    Hi josh,

    You make some good points. Part of this initial discussion (and the poll on my homepage) is to see what others out in the market think.

    the last two years have shown that the market thinks the RMB is undervalued, and thus everyday we see new lows. the government widened the band a few months back knowing full well the RMB would continue to gain on the dollar, and that is exactly what it has done…. it has been gradual, the market has so far been able to absorb, and should there be any big red lights in the market that something was about to happen the brakes could be applied.

    not a bad plan in the Chinese eyes….

    but then again, the U.S. always has their own plans…

  5. Greg Cruey says:

    November 14th, 2007 at 12:43 pm

    With a little time now passed since you wrote this, I think it is interesting the different political perspectives that have come out on the issue of the exchange rate. Bush talks about a strong dollar but seems to promote a weak dollar, probably to improve out exports. And he wants China to have a stronger yuan to weaken their exports. If there is a moral principal driving policy anywhere in this, I’m missing it…
    http://www.chinaventurenews.com/50226711/the_dollar_the_yuan_the_president_and_the_price_of_oil_a_rant_i_suppose.php

  6. Rich says:

    November 14th, 2007 at 8:33 pm

    Greg,

    Thanks for passing that on. your points are well said, and I can only hope that you become representative of the majority rather than fighting as part of the minority!

    Moral guiding principles in the current administration are difficult to find in almost every facet. Where the political path of least resistance meets the US economy, it is easier to blame the Chinese than to look at the fact that rampant consumerism and cheap credit in the US has a large part in this and many other domestic issues right now.

    Have a good weekend and thanks
    R