It’s no secret that many economists believe China’s currency is wildly undervalued and many politicians detest Beijing’s stubbornness to discuss changes to the country’s longstanding currency policy. But as China’s importance to the world economy has surged–it is expected to account for a significant portion of global GDP growth this year–the country’s political clout has grown as well. Despite concerted efforts of numerous world leaders, a revision to the yuan-dollar peg had recently seemed very unlikely, especially after Prime Minister Wen Jiabao told the National People’s Congress last month that the currency would remain “basically stable.”
But that might not be the case after all. The Chinese government is reportedly set to announce changes to its currency policy within a few days. According to sources within Beijing, the revisions would allow for greater variation in the value of the Chinese currency, and also provide for an immediate jump in value relative to the U.S. dollar. As described, the move would be similar to a decision in 2005 to let the renminbi appreciate 2% against the greenback overnight and trade in a wider (albeit still relatively narrow) daily range. “For the coming announcement, however, China is likely to emphasize that the value of the renminbi can fall as well as rise on any given day, so as to discourage a flood of speculative investment into China’s betting on rapid further appreciation,” writes Keith Bradsher.
While most with knowledge of the government’s thinking have been hesitant to discuss openly because of the sensitivity of the issue within China, hints of the policy shift began leaking out. Xia Bin, a member of the monetary policy committee of the Chinese central bank, expressed his opinion on the matter on Thursday. “At a certain point, when necessary, it is better to have a quick, prompt appreciation in a bid to fend off speculative capital,” Xia told reporters. Investors have picked up on the rumors of a revaluation as well; trading in the WisdomTree Dreyfus Chinese Yuan Fund (CYB), which had an average daily volume in 2010 of about 340,000 shares, surged nearly tenfold on Wednesday to 3.4 million.
Chinese Yuan ETF Options
The introduction of currency ETFs has sparked a huge interest in the Chinese yuan, a trend reflected by the impressive growth of CYB. At the beginning of 2009, this fund had less than $100 million in assets under management; CYB has now grown to more than $660 million. Recent developments are likely to send more cash into yuan ETFs.
Although a number of potential snags–as well as the general unpredictability of the Chinese government–could derail the decision, an upward revision of the yuan in coming weeks seems very likely. What remains to be seen, however, is the amount by which Beijing will allow its currency to jump immediately and the width of the new trading range. As details over these two factors become clearer, trading in CYB and the much smaller Market Vectors Chinese Renminbi/USD ETN (CNY) should remain heavy. While both of these exchange-traded products offer U.S. investors a way to play a strengthening yuan, there are some pretty big differences between these products.
First, as its name suggests, CNY is structured as an exchange-traded note (ETN); it is a senior, unsecured debt security issued by Morgan Stanley that seeks to track the performance of the S&P Chinese Renminbi Total Return Index (see a list of all currency indexes here). While a Morgan Stanley bankruptcy is unlikely, CNY nevertheless comes with some credit risk.
CYB, on the other hand, is an actively-managed currency fund that seeks to achieve returns reflective of both money market rates in China available to foreign investors and changes in the value of the Chinese yuan relative to the U.S. dollar. So this fund’s holdings (available here) consist of various repurchase agreements, T-Bills, and government and corporate bonds, as well as currency contracts. This explains part of the gap in year-to-date performance between CYB and CNY, since the money market rate in China is slightly negative (CYB has a 30-day SEC yield of -0.29%).
There’s also a relatively small difference in expenses; CYB charges 0.45% compared to 0.55% for CNY. But the biggest difference between these yuan ETFs relates to their underlying holdings (or lack thereof); CYB essentially offers exposure to Chinese money market accounts, while CNY is a debt security whose returns are linked to the exchange rate.
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Disclosure: No positions at time of writing.