Currency Games

Well well well! So China has agreed, in a roundabout vague way, to allowing a freer float of its currency the yuan. This was ostensibly the big news over the weekend. But what does it really mean?

During the financial crisis of 2008, China halted the managed free-float of the yuan and pegged its value to the dollar at 6.83. This meant that no matter how weak the U.S. dollar got, the Chinese currency would always remain relatively cheaper. This was a boom to Chinese exporters.

A stronger local currency might mean China is changing gears in its economic growth plan. That is, rather than relying on export-driven GDP growth, it will shift toward more domestic demand (people spending money). According to the Financial Times, consumption as a percentage of GDP in China has actually fallen from 45% to 35%. In other words, Chinese economic growth has become even more export reliant.

Is that changing now? Hmm. We’ll see. For Australia, there’s an argument to be made that a stronger Chinese currency is bullish for commodities. China can use its stronger currency to buy more tangible assets and fewer U.S. Treasury bonds. And maybe the unleashing of Chinese domestic demand will boost demand for certain Australian resources that are used in the production of finished consumer goods and not capital goods.

Maybe. The other take on the China move is that it’s a race to the Keynesian bottom globally now. We’ll save the explanation for tomorrow. But it could be that the mantle of leadership for engineering global inflation has shifted East over the weekend.

Let there be no doubt, though, the mantle of manufacturing leadership has definitely shifted east. According to US research firm IHS Global Insight, China is set to overtake the US in the dollar value of its manufactured goods output by next year. The mercantilist export policy has worked in incentivising global manufacturers to either move to China…or shut their doors because they cannot compete on unit labour costs.

IHS reckons that this year U.S. manufactured goods will account for 19.9% of global output while China-sourced goods will account for 18.6%. The U.S. has held the lead in this category since 1890, when it assumed the title of “world’s workshop” from Great Britain. With such a long run at number one, is this evidence of the Money Migration…the gradual shifting of the world’s economic balance of power from the Western Welfare States to the managed economies of the East?

Well, to some extent the statistics are probably misleading. The goods may be made in China. But who makes the profits from their sale? In the age of multinational corporations and long supply chains, the source of the manufacturing may be less important (from an investment perspective) than who has the best margins in the whole process (raw materials, capital goods, finished goods, retailers).

But the big picture? China seems to be growing its capital stock at a faster rate than the United States. A big global debt-deflation will certainly reduce consumer demand everywhere. But when the global economy adjusts a lower equilibrium (with less credit in the system) where will all the factories be?

Switching to another tangible asset, did you see that gold made a new high in the spot and futures markets? Spot gold hit $1,261.90 in New York trading while the August futures contract hit $1,263.70. This prompts the question among those new to gold: is the high in?

Obviously, we don’t think so. When you’re talking about the end of the super cycle in fiat money, gold’s ceiling is considerably higher. Although, if you take a look at the chart below, it shows that silver might be the better speculation right now. It’s lagged gold’s recent move, judging by the gold/silver ration (the number of ounces of silver it takes you to buy an ounce of gold using spot prices).

If you think we were bit a bit shrill and vulgar in venting our anger at the morons and vandals who are damaging Australia’s reputation in their campaign to bore Australians to death while also stealing money from projects they bore no investment risk on, maybe you’ll enjoy the comments of John Ralph more.

Ralph writes that the Rudd tax has increased Australia’s sovereign risk. He adds that, “Where sovereign risk is perceived to be an issue, two consequences follow. Capital becomes more difficult to obtain to fund activities in the nation generally, and it becomes more expensive, including for the funding of budget deficits, because the perception of sovereign risk gets priced into financial transactions. It is this factor that mostly concerns me because of its implications for the community over a lengthy period into the future.”

“Collecting a higher level of taxation from the mining industry for government to disburse for other worthwhile purposes may be perceived as a positive contribution to the Catholic principle of the ‘common good’. However, if a badly designed and executed change results in much reduced government revenue in the future and a higher cost of funds that Australia, as a capital importing country, requires, then the contribution to the common good is negatively affected. Such an outcome would impact on the whole community, because borrowing will be more expensive.

More on what higher borrowing costs would mean to Australia’s property market tomorrow. And incidentally, we are pleased to announce that we will be debating the housing market in Sydney on July 6th. We can’t say who our opponent will be yet. But we think you’ll recognise the name.

Dan Denning
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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this statement is crap. “The mercantilist export policy has worked in incentivising global manufacturers to either move to China”. The Volcker/Reagan camp decided to nuke the brownbelt and export the production to China rather than to take the hard decisions. They used public debt plowed on a pump primed basis into the high end military-industrial-telecommunications-aero industries and trickle down into service industries. All of a sudden there was jobs all over America in teaching people how to use phone handsets. And don’t think the US was the only country to face the same problem, Germany did it in the 80’s… Read more »
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