Apr 16, 2012

A Contrarian View on China's Currency Move

The latest push by Beijing to accelerate the opening of China's capital account to foreign investment is undoubtedly a good thing. A good thing for the world as it helps reballance the global economy. However it is being hailed as a cure-all for China's slowing economy in China Currency Move Nails Hard Landing Risk Coffin. Not meaning to pick on Paul Markowski here (although as long-term adviser to Beijing he is hardly impartial) - this is the general view across the financial media at the moment.

We believe it is also incorrect. Beijing is clearly aware of the undeserved benefits that acrue to the
issuer of the world's reserve currency. Lower borrowing costs, the ability to use financial leverage for political means (i.e. the US embargo over Iran) and many others would only be in China's reach if the yuan were to become fully convertible.

The timing of the recent increase in QFII quotas (discussed on WhatIf in The Landing Will Be Hard) and Saturday's widening of the yuan's trading band comes on the heels of a slowdown in China's economy. Last Friday Q1 GDP disappointed at +8.1% YoY against expectations of +8.3%. This is by all means quite robust by developed world standards. However for an economy with Investment / GDP ratio of over 40%, any slowdown can be detrimental. China can either soar or collapse. Orderly slowdown is not in the cards.

This brings us to the signal that Beijing's capital control policy has been sending out. The export-oriented growth model has started to crumble, with factories in Guangdong closing down and the country's current account surpluses starting to reverse. The only way to fuel a continued economic expansion on the scale needed to sustain the high operational leverage in the economy is a massive investment boom fueled by foreign capital.

(For more WhatIf posts click here)