Consequences of a stronger Renmimbi for the global economy

Mike Browne of Seed Investments writes that it is always difficult to keep up with the multitude of news and information that lands on your desk, but after a while you realise where the good sources of information come from.

Reports from these sources typically get read as soon as they arrive, but if you are too busy when they arrive you make sure that they get filed for later consumption.

One of the global managers that we make sure we track is Sarasin, with their Chief Investment Officer (CIO) and Managing Partner being the well respected Guy Monson. Sarasin’s Quarter 3 – 2010 report came out on 22 July 2010. Fortunately Sarasin invests with a long term horizon, so reading this report late doesn’t have much impact on the relevance of the report.

The report starts off with the People’s Bank of China quote,

“In view of the recent economic situation and financial market developments at home and abroad, and the Balance of Payments (BoP) situation in China, the People’s Bank of China has decided to proceed further with reform of the RMB exchange rate regime and to enhance the RMB exchange rate flexibility.” – 19 June 2010

After this announcement the Renminbi (RMB) – official name of the Chinese currency, also known as the Yuan – strengthened versus the US dollar (USD) as indicated in the chart below. Note the historical USD peg before the revaluation.

After this announcement the Renminbi (RMB) – official name of the Chinese currency, also known as the Yuan – strengthened versus the US dollar (USD) as indicated in the chart below. Note the historical USD peg before the revaluation.

After this announcement the Renminbi (RMB) – official name of the Chinese currency, also known as the Yuan – strengthened versus the US dollar (USD) as indicated in the chart below. Note the historical USD peg before the revaluation.

The US has been engaging China for many years now about its exchange rate. The US felt that the Chinese were keeping their exchange rate artificially weak in order to support their exports – which form a large part of the Chinese economy. By allowing the RMB to strengthen, the Chinese have made other countries’ goods more attractive, on a relative basis, and helps these countries’ (including the US) economies. Conversely RMB strength will put pressure on China’s economy as the USD price of their goods increases.

With this background in mind, the one sentence from Guy Monson that really resonated with me was as follows,

(Speaking about the strengthening Renminbi) “Over time the advantages are clear; it will tend to be reflationary for the global economy and deflationary for China (which should benefit both), it will reduce trade friction and rebalance global demand.”

The stronger RMB will lead to inflation in the countries that are major importers of Chinese goods (mainly western consumer driven countries). Generally this would be cause for concern, but at the moment these economies are struggling with weak economies and near deflation and so some inflation will be a welcome relief. At the same time, reduced demand for Chinese products will not only put pressure on the Chinese economy (thereby cooling an overheating economy – inflation is now over their 3% target) but it could also be the catalyst for a transition in the Chinese economy from being hugely reliant on exports to becoming a more consumer driven economy. These are both positive factors in the long run.

Sarasin are playing this theme by investing in short term Asian bonds – to benefit from potential flows into these economies – and in what they deem ‘Nifty Fifty’ stocks. Nifty Fifty stocks are global companies (typically listed on Developed Market exchanges) that are export driven and cash rich. The valuations of these companies are attractive and they benefit from growing demand of their product in Emerging, particularly Asian, countries.