Tuesday, November 23, 2004

Two items on foreign exchange. First, Li Rougu of the PBOC has once again tried to dampen expectation of a yuan revaluation, saying that China will not do so "under pressure." However, this could all just be a game they are playing before they actually revaluate. They did something similar before they raised interest rates. The more important issue that I read in a report is that China might simply be unprepared for a wider trading band on the yuan. Even a loosening of 5% will involve reprogramming a lot of forex systems, so they have to get it all ready before the move canbe made. Also, contrary to my previous guess, it doesn't seem like they will switch to a basket peg, since most trade activities are done in the dollars.

The second article from the WSJ further confirms the market's expectation of a continual devaluation of the dollar and revaluation of Asian currencies. I have to say that there is a limit to this, since most Asian countries rely on export to the US and most of their forex reserves are denominated in the dollar. If they revaluate, they will suffer in decreased export and suffer a loss in their reserve. Europe is particularly grapping with the first problem. I think there will be coordinated intervention by Europe, Japan, and perhaps Korea to save the dollar some time soon. In 20 years, when the yuan becomes fully convertible, I am not sure if they will continue to save the dollar.....

By James Kynge in Beijing, Chris Giles in London and James Harding in SantiagoPublished: November 22 2004 In a mark of China's growing economic confidence, the country's central bank has offered blunt advice to Washington about its ballooning trade deficit and unemployment.In an interview with the Financial Times, Li Ruogu, the deputy governor of the People's Bank of China, warned the US not to blame other countries for its economic difficulties.China's custom is that we never blame others for our own problem,?said the senior central bank official.For the past 26 years, we never put pressure or problems on to the world. The US has the reverse attitude, whenever they have a problem, they blame others.?br>Mr Li insisted an appreciation of the Chinese currency would not solve the US's structural problems and that although China was gradually? moving towards greater exchange rate flexibility, it would not do so under heavy external pressure.under heavy speculation we cannot move [towards greater flexibility] and under heavy external pressure we cannot,?said Mr Li. o the best environment for us to gradually move towards a more flexible exchange rate is when people don't talk about it.

His comments will disappoint US, Japanese and European politicians. Pressure has mounted on the Chinese administration to revalue the renminbi or to increase the flexibility of the Chinese exchange rate over the past two years.Mr Li said China could only permit greater renminbi flexibility after creating a domestic financial infrastructure, including reformed banks and developed markets, able to cope with a more liberalised currency mechanism; considering the conditions and the wishes of neighbouring Asian economies on any move towards a more flexible system; and educating people on how to deal with a new exchange rate system, teaching them how to hedge.Mr Li, who spoke before a meeting of the Asia-Pacific Economic Co-operation (Apec) forum last weekend, said China did not want to run trade surpluses or accumulate foreign currency reserves. Its reserves stand at $515bn.If there is a small deficit, we are not concerned. But certainly we don't want to run into the US situation of having a trade deficit of 6 per cent of GDP,?he said.That is not sustainable,?he added. The appreciation of the RMB will not solve the problems of unemployment in the US because the cost of labour in China is only three per cent that of US labour. They should give up textiles, shoe-making and even agriculture probably.They should concentrate on sectors like aerospace and then sell those things to us and we would spend billions on this. We could easily balance the trade. China's timetable for freeing up the renminbi is expected to have an impact on sales of US goods to the mammoth and growing Chinese market as well as the consumption of Chinese goods in America.The recent, adjustment to Chinese interest rates is seen by some in Washington as evidence that Beijing accepts administrative measures that are no longer an effective means of managing an increasingly liberalised market.At last weekend's G20 meeting, finance ministers and central bank governors called for a global effort to reduce trade imbalances, and in partiuclar, the US current account deficit. John Snow, the US treasury secretary, repeated his commitment to work towards halving the US budget defict and to increase net US national saving, which would reduce the current account deficit.But President George W. Bush's assurances at the weekend that his administration is committed to a strong dollar policy appeared to do little on Monday to encourage buying of the dollar, evidence of how far the White House's credibility on currencies has been undermined by the rising deficit. In mid day trading in New York the dollar was at 1.304 against the euro and 103.21 against the yen.

Asia Bets on Stronger Currencies
Investors Jockey for PositionIn Stocks, Bonds on SignsChina May Ease Yuan's Peg
By PATRICK BARTA in Bangkok, Thailand, and ANDREW BROWNE and MARY KISSEL in Hong Kong Staff Reporters of THE WALL STREET JOURNAL

November 23, 2004; Page A2

Asia appears to be in the early stages of a regionwide currency revaluation, partly in anticipation that China will let its own currency float higher sometime in the next year.
From Tokyo to Seoul to Singapore, some investors are buying up large volumes of Asian currencies, a strategy that assumes Asian countries will tolerate somewhat stronger currencies in the year ahead. The South Korean won is trading near its highest level against the dollar in seven years, while the Japanese yen is up nearly 7% since the beginning of October.

Investors also are pouring capital into Asia's equity and bond markets -- a bet that appreciating currencies will boost the value of their assets over time. Meanwhile, a number of Asia's largest companies are drafting strategies to deal with current and anticipated adjustments in Asian currencies, including cutting costs and changing the amount of business they do in dollars.
"There is beginning to be a little smoke out of that volcano that we're going to see something" in terms of stronger Asian currencies over the next year, says Frank Vargo, vice president for international economic affairs at the National Association of Manufacturers in Washington, which long has lobbied for more-flexible currencies in Asia.
Further revaluation in Asia still is far from certain. With export growth slowing across Asia, many governments could decide further appreciation is too risky as stronger currencies could make their exports less competitive by making them more expensive on the global market. Indeed, traders said South Korean authorities intervened to buy dollars yesterday in an effort to boost the dollar and slow the appreciation of the won. (See related article.)
A modest revaluation of Asia's currencies wouldn't solve the gaping U.S current-account deficit. That deficit -- the shortfall on trade and investment income between the U.S. and the rest of the world -- has widened because the U.S. economy imports far more goods than it exports, forcing the U.S. to borrow heavily from China, Japan and elsewhere to finance its purchases. As the U.S. falls deeper into debt, economists warn, some investors might decide to pull their money from U.S. markets. That could trigger a sharp fall in U.S. asset prices and a sudden surge in interest rates, which in turn might cause a global recession.
Meanwhile, a sizable revaluation could create problems for some Asian countries by cutting the value of their huge foreign-exchange reserves, leading to hefty balance-sheet losses. This is especially true for China, which has $515 billion of foreign-exchange holdings, equivalent to about 30% of the country's gross domestic product.
Still, analysts say there are a number of reasons Asian governments may be growing more tolerant of upward currency moves.
For one thing, China has hinted it is planning to relax its currency's tight peg to the dollar as part of a strategy to give Beijing more leverage to cool its overheated economy and lessen tensions with the U.S. (See related article.) Beijing is likely to cap any currency fluctuations within a "small" range and may link the yuan to a basket of currencies, a person familiar with the government's thinking said. This person wouldn't define "small" but said 5% could count as small while 10% would be "big."
If China does act, it could give other Asian governments more flexibility to follow suit. China's neighbors are wary of letting their currencies appreciate too much without a simultaneous increase in the yuan, as doing so would make their manufactured goods less competitive.
Stronger currencies also could help Asian governments take some of the sting out of high oil and commodity prices by giving consumers and factory owners more purchasing power. Inflationary concerns are especially prevalent in South Korea, which is scrambling to avoid "stagflation" amid weak consumer demand and rising prices.
Finally, many analysts believe there is a growing recognition in Asia that the global trade imbalance is unsustainable, and that some appreciation of their currencies is necessary to prevent more-drastic -- and uncontrolled -- moves later on. The recent slide of the dollar against the euro has highlighted those risks, analysts say.
In a conference call with clients last week, Lehman Brothers' global currency strategist, Jim McCormick, said he believes the yuan will be 5% higher by the end of 2005 while some other Asian currencies could rise as much as 15%. "Asia is willing to tolerate much stronger currencies than most were thinking even a few weeks ago," he said.
In one way, Asia is experiencing a reversal of the currency crisis that swept the region in 1997. Then, Beijing helped to prevent a greater rout of Asian currencies by pledging not to devalue, turning the yuan into an anchor of regional stability. Now, the region is looking to China to pull up the anchor so that its currencies can rise in value, a sign the region has weathered the storm and is ready to sail on.
Indeed, in some ways a further decoupling of Asian currencies from the dollar could help aid the region's march to a healthier economy. To ensure their currencies move somewhat in tandem with the dollar, Asian central banks have been buying dollars and piling up foreign-exchange reserves. If they allow their currencies to rise, they will buy fewer dollars, in effect keeping more Asian savings at home, a move that could deepen capital markets in the region.
Even slightly revalued currencies would represent an important symbolic shift for Asian countries, many of which have kept their currencies at artificially low levels since at least the late 1990s. Analysts believe some Asian currencies are between 10% and 20% below the levels at which they would trade if floated freely.
Many Asian companies are proceeding as if further revaluations are inevitable. As it puts together its business plan for next year, South Korea's LG Electronics Co. says it believes the yuan will appreciate between 5% and 10% next year, but it is preparing for a rise of as much as 15% just to be safe.
Investors, meanwhile, are moving money into Asian stocks and bonds.
Many investors have been selling shares of some of the region's biggest exporters, however, a reminder that any meaningful revaluation would likely cause significant pain for many Asian companies in the short run.

I guess the yuan will be re-evaluted at a time when it is least expected. Andy Xie says right now there are 1 trillion US$ hedge fund betting on the appreciation of the yuan (the figure looks too high to be true to me, though), so obviously it's not a good time to re-evalute it now. China will try to hold on for as long as possible. But of course foreign investors also know this, so the result of the game will depend on who can hold on longer. a really interesting game to watch.
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