President Barack Obama embarked this week on a critical trip to China, seeking to gain support for tougher economic sanctions against Iran during meetings with Chinese President Hu Jintao. But as the U.S. president was setting out to present his case, the controversy over the relative value of China’s currency, a delicate issue for U.S. officials, fired up once again.
Between 1997 and 2005, the yuan was pegged at a rate of 8.27 yuan per U.S. dollar before the government allowed the currency to float at a band of 0.3% around a rate published by the People’s Bank of 2007 (the band was subsequently increased to 0.5%). For the last 18 months, the yuan has been held in place against the dollar at a rate of approximately 8.83 yuan per dollar, a policy that has irked many U.S. officials, most notably Treasury Secretary Timothy Geithner.
In a speech to a finance forum, International Monetary Fund (IMF) chief Dominique Strauss-Kahn said that a stronger yuan would help boost China’s economy, joining a long like of economists and politicians who have called for Beijing to loosen its grip on the currency. “Allowing the renminbi and other Asian currencies to rise would help increase the purchasing power of households, raise the labor share of income, and provide the right incentives to reorient investment,” said Strauss-Kahn. “Higher Chinese domestic demand, along with higher US saving, will help rebalance world demand and assure a healthier global economy for us all.”
Last week, the Asia-Pacific Economic Cooperation (APEC) forum called for greater exchange rate flexibility (read: allowing the yuan to strengthen against the dollar), noting that APEC members should follow “monetary policies consistent with price stability in the context of market-oriented exchange rates that reflect underlying economic fundamentals.”
China’s Commerce Ministry has pushed back on calls from abroad to let the yuan appreciate. “Either from the perspective of promoting stable global economic development, or from the perspective of promoting a recovery in Chinese exports, we must provide a stable and predictable environment for our enterprises, including macro-economic policy and currency policy,” said Ministry spokesman Yao Jian earlier this week. While China has recovered from the global economic downturn far better than most nations, some economists believe that the government would have to see a significant uptick in export activity before it would consider loosening its grip on the currency.
For investors considering an allocation to China, consideration must be given to the future of the country’s currency. As this saga continues to play out, there are several possible outcomes:
China Allows Yuan To Float Against Dollar: The “dream scenario” for many interested parties, a complete elimination of the dollar peg would likely result in a significant increase in the value of the yuan. As China’s economy has sped ahead of the developed world, its economy has become less dependent on exports for growth. But such a large concession is extremely unlikely, as the government will have tremendous concerns over the short and long term impacts on the economy. Odds: 1,000/1
China Allows Yuan To Strengthen By 5% to 10%: Despite China’s touch stance, many economists feel that the government’s may be forced to concede to some degree of currency appreciation or else face extreme inflation. A 4 trillion yuan stimulus plan and record lending may lead to an uptick in inflation in coming months, a trend that may require a slight easing of exchange rate restrictions. RBC is predicting that the yuan may strengthen to 6.50 against the dollar by the end of next year from its current level of 6.83. Odds: 3/1
China Keeps Dollar Peg Firmly In Place: China has publicly demonstrated that it will not give in easily to requests for a revaluation easily, citing numerous reasons for its firm position on the currency issue. Given the lack of leverage the interested parties hold in the matter, this seems to be a very likely scenario. Odds: 3/1
Chinese Yuan ETFs
For investors looking to gain exposure to the dollar/yuan exchange rate, there are several ETF options:
- WisdomTree Dreyfus Chinese Yuan Fund (CYB): This ETF seeks to achieve total returns reflective of both money market rates in China available to foreign investors and changes in the value of the yuan relative to the dollar. According to WisdomTree, money market rates in China are near-zero, similar to U.S. rates. As speculation about the future of the relationship between the dollar and yuan has heated up, volume in CYB has surged, but the share price has remained relatively stable (see charts of CYB here).
- Market Vectors Chinese Renminbi/USD ETN (CNY): This ETN is a senior, unsecured debt instrument issued by Morgan Stanley that delivers exposure to the exchange rate of the Chinese renminbi and U.S. dollar. As such, this investment would reflect primarily movements in the exchange rate, whereas CYB reflects both exchange rate movements and yields on a money market account in China. CNY has returned about 2.4% year to date and 3.1% over the last 52 weeks (see technical analysis of CNY here).
- WisdomTree Dreyfus Currency Fund (CEW): This ETF seeks to deliver returns reflective of both money market rates in selected emerging market countries and changes in the value of these currencies relative to the dollar. CEW invests in a basket of emerging market currencies, one of which is the Chinese yuan (see more information on CEW’s fact sheet). For investors looking to gain exposure to the yuan along with currencies that offer real money market return rates, CEW may be an appealing option. ETFdb Pro members can see how we use CEW in our Alpha Seeker 2.0 Portfolio (if you’re not a Pro member yet, you can sign up for a free trial or read more here).
Disclosure: No positions at time of writing.