China’s Historic De-Pegging Is Much Ado About Nothing

China’s Historic De-Pegging Is Much Ado About Nothing

By Justice Litle, Editorial Director, Taipan Publishing Group

China’s de-pegging announcement got the currency bulls all hot and bothered this week. The excitement was most definitely premature.

This past weekend, an announcement of great importance came forth from China. To kick off a “new era,” we were told, the Chinese yuan would be de-pegged from the U.S. dollar.

Excitable types on the long side of the market thought this a very big deal. Stocks gapped open higher to start the week, with emerging market equities faring particularly well. But it wasn’t long before currency markets sagged as reality came to light: The West had been juked once again.

To be “juked” – or, more fully, “juked out of one’s shoes” – is an American football term. Roughly, it means to be faked out, played for a sucker, or otherwise made a fool of, by a sufficiently fleet-footed opponent.

The art of the juke requires natural dexterity and the ability to game a defender’s intentions. The would-be juker will typically “feint” or “dance” in one direction, push hard off a planted foot, and then quickly pivot the other way. If done correctly, the defender may even fall down in a heap upon lunging into empty space.

That is more or less what happened to the China currency bulls this week. All kinds of good things were supposed to happen with the revaluation of China’s currency. And those good things may indeed happen – some far off day well down the road. Trouble being, we have zero idea when.

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The implied promise of the de-pegging is that China’s currency will be allowed to rise (in comparison to the $USD). Less trumpeted is the fact that the yuan can actually fall now as well.

While the PBOC (People’s Bank of China) may give the yuan a bit more elbow room, they are quite likely to stick to the super-tight range they have maintained for some time now. How tight is super-tight, you ask? Here is one way to look at it: Over the past two years, the WisdomTree Yuan ETF (CYB:NYSE), has traded in roughly a one-dollar range… a max fluctuation of four percent on the $24-and-change buy price.

The timing of the de-pegging announcement was laughably political. Given the upcoming G-20 meeting in Canada, the dragon’s primary goal was to deflect protectionist heat.

“Don’t look at us! We’ve listened to your requests – see? We let the yuan rise in value by a whopping 0.4%! (Never mind that it fell back the very next day…)”

If you listen hard, you can almost hear the snickers from Beijing. As hopers grasp at straws, the mandarins laugh up their sleeves…

(By the way, you should read what my fellow Editor Adam Lass thinks about China. Sign up here for his investment commentary.)

Why China Will Stay Its Hand

There are multiple reasons why the dragon cannot afford a meaningful strengthening of the yuan in the near term, much as the U.S. and Europe might wish it so. Here are a few:

• Hot money inflows. Were the yuan to rise swiftly, a flood of “hot money” inflows could rush in and destabilize China’s home markets, some of which are already quite frothy. The PBOC has been careful to deter currency speculators by quashing hopes of a quick pop.
• Export sensitivity. There is a ways to go yet before domestic consumption takes over as the key driver of China’s economy. For now, the dragon’s ability to export manufactured goods remains a vital growth prop… and that means high sensitivity to export competitiveness, which would be hurt by a suddenly stronger yuan (especially given spending slowdown trends in the West).
• Labor competitiveness. China is already enduring a series of factory strikes and forced wage hikes as workers demand better pay. These higher wages reduce China’s competitiveness as an outsourcing destination, and a strengthening currency could further encourage multinationals to look to China’s neighbors. Given its full-employment mandate, Beijing can ill afford such a trend.
• Real estate risks. China’s real estate market is hot – smoking hot – and that means trouble when the bubble bursts, of the sort that an overly strong currency would only make worse. As the LA Times reports, “Home prices in major cities including Beijing and Shanghai have easily doubled over the last year as families and investors rush to grab a piece of the Chinese dream. A typical 1,000-square-foot, two-bedroom, one-bath apartment in the capital now costs about $274,000. That’s 22 times the average annual income of a Beijing resident…“

Saying Goodbye to Santa Claus

Ever since China led global markets off the 2009 lows last year, responding to the crisis with a half-trillion-dollar stimulus package and a burst of economic vigor, investors have come to regard the dragon as a sort of Santa Claus… a benevolent spreader of hope and cheer, handing out investment gifts to good little boys and girls.

Global economy looking down in the mouth? China will lead us back to the promised land. Commodity investments in need of a boost? China will hoover up excess supply. U.S. debt levels looking scary? China will soak up the excess there too. U.S. consumers looking tapped? Chinese consumers to the rescue. And so it goes.

There is an element of logic to the above expectations, but more than a dollop of wishful thinking too. The reality is that China is no benevolent savior… that the debt-driven problems we face are still real and deep… and, last but not least, that “hope” does not count as a legitimate strategy (and never has).

In sum, the de-pegging of the yuan is indeed good news from a longer-term perspective, as China moves one baby step closer to the “free markets for free men” ideal that greases the wheels of global trade. But in the short run, the news is much ado about nothing.

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About the Author:

Justice Litle is the Editorial Director of Taipan Publishing Group, Editor of Justice Litle’s Macro Trader and Managing Editor to the free investing and trading e-letter Taipan Daily. Justice began his career by pursuing a Ph.D. in literature and philosophy at Oxford University in England, and continued his education at Pulacki University in Olomouc, Czech Republic, and Macquarie University in Sydney, Australia.