Yuan

The latest IMF Currency Composition of Official Foreign Exchange Reserves report was just released. In the quarter ending March 31, the biggest relative drop occurred in central bank holdings of Dollars, declining as a percentage of total reserves from 62.2% in Q4 2009 to 61.5% in Q1 2010. This is the lowest ever relative holding of US Dollars by foreign banks. Oddly enough, the euro was not the biggest beneficiary of this loss of confidence in the dollar (it also declined on a relative basis by 0.1% as a % of total holdings to 72.2% in Q1), but the "Other" currency category. We assume that the Chinese Yuan is the dominant currency in this particular basket. Other reserves increased from 3.1% of total to 3.7% in just one quarter. Central banks are starting to rotate holdings out of Dollars (and after this quarter, certainly out of euros) and into non-traditional, non-developed currencies. Are China and Russia slowly becoming reserves?

Yesterday's mega news on the CNY depegging, which went so far as to make headlines out of something as mundane as the PBoC yuan fixing, has now been fully priced in. And before we put the matter to rest, we would like to present two diametrically opposing opinions on this issue: one from Goldman's Sven Jari Stehn, which is full of contained optimism about the future of the world, and one from Gary Shilling, who in a Bberg TV interview, says that the Chinese decision could not have come at a worse time, and that it risks destabilizing the precarious global balance achieved at the cost of so many trillions in stimuli.

The market just added one more bank to its daily intervention watch. The PBoC, which left the CNY fixing unchanged from Friday at 6.8275, is now being tested by the market, which is trying to determine what the real trading band is. At last check, the USDCNY was at 6.8125. So far the daily band has been pushed beyond 0.002% and the PBoC has not yet intervened, or at least not in a manner comparable to that we have grown to love and disrespect from the SNB. In the meantime, just so there is no confusion, Former Chief Executive of the Hong Kong Monetary Authority, Joseph Yam says the "Yuan may appreciate or depreciate in short-term." Well, that now makes it all clear.

On Sunday, the People's Bank of China (PBOC) has ruled out the one-off revaluation that US politicians had sought. For now, analysts still expect the yuan to slowly rise. Meanwhile, the decision by China should not have come as a surprise as there are several major risks should China implement a faster yuan move as favored by many.

Somebody forgot to give the PBoC the memo about that whole "PBoC eliminating the dollar peg" thing. According to the just released fixing by the Chinese Central bank, the USDCNY today was at 6.8275, the exact same as Monday. And adding just a little insult to injury, the PBoC devalued the CNY against the EUR by juar under 300 pips: from 8.4538 to 8.4825. That's ok though, the HFT brigade already has its wax on, er, risk on, no volume marching orders.

What do you do when your last multi-trillion stimulus is expiring and its effects no longer generate asset bubbles as you once did? Why, you launch another multi-trillion stimulus of course, although if you are the US you call it something funky like Pennies for Prosties, Benjies for Bodyrubs or something comparable. China has no problems with nomenclature so it calls it how it is: as Bloomberg observes, "China will announce in August a new stimulus package of possibly 4 trillion yuan ($586 billion), the China Business newspaper reported on its Web site, citing unidentified sources. The plan, from China’s National Development and Reform Commission, will likely cover nine industries including information technology and new energy, the report said." So much for monetary prudence. At this point all economies will spend money into overdrive until each and every economy (that can print its own currency) simply implodes into a Keynesian supernova.

Gary Shilling is now firmly in the anti-China contrarian bandwagon. In this interview with Bloomberg's Erik Schtazker the legendary investor, who called Japan's lost decade when everyone was just as bullish on Japan as Goldman is now on China, Shilling shares the same view on Chinese record excess capacity as Hugh Hendry did some months ago: "You can't trust the [Chinese] numbers... They have kickstarted their economy in the last year - it's a stop go economy, they can do it fast, they don't have to worry about EPA audits, they just let the bulldozers roll when they want to build a new road or whatever. The point is they build an awful lot of excess capacity and the question is how are they going to use it because American consumers aren't buying their exports the way they used to and their domestic economy isn't that strong... Chinese consumer spending is 36% of GDP and is a declining share over the last two decades. They don't have a a big enough middle class. In China there were 110 million people with over $5k per capita income, enough to give them discretionary spending but that was only 8% of the population. In this country it is 80% of the population." And on the yuan: "If they took off all the controls and Chinese could invest abroad, the yuan would probably go down because people would want to diversify... I think the political leaders are aware of that possibility they sure don't want to be pushed around, and Obama made a huge in trying to push them again. Remember China was dominated by European in the last century and they want to run their own country." While we completely agree with Schilling, we believe that the current transformation in US society, which is in the last throws of contract abrogation, in not paying mortgage and credit card bills, we may well see a last push in Chinese imports, after which any disposable income in the US middle class will plunge and will take the US economy down with it as well. The problem, as we have repeatedly pointed out, the cash return on such "assets" as iPads and Kindles is zero, not nearly enough to pay down 39.95% APR credit cards.

Over the last ten years, the Renminbi (RMB) or yuan, has been slowly gaining influence in the markets that surround mainland China. And about one year ago Hong Kong introduced a new trade settlement that allowed Hong Kong business’ to use the RMB as a trading currency. In a China Daily interview, Dr. Billy Mak, Associate Professor in Finance at Hong Kong Baptist University believes the yuan overtaking the dollar will happen in three phases.

In what could be a first step to appeasing the US and its requests for CNY revaluation, Caijing has reported that China may be considering expanding the daily yuan trading band. The yuan currently fluctuates up to 0.5% around the central CNYUSD parity set by the PBoC - today, for example, the CNY was stronger by 1 pip from 6.8264 to 6.8263. As reported by Market News, citing an
unidentified Chinese government source, "If the central bank does not want to see a quick rate hike, a
better way to fight inflation would be to expand the daily yuan trading
band to allow the yuan to appreciate properly." One interpretation of this development is that China, anticipating a delay of the Treasury report widely expected to brand China a currency manipulator, will placate the US just marginally and split the baby in the middle, by allowing a trading band expansion. Of course, this will do nothing to actually revalue the Yuan, devalue the dollar and boost US exports, but it will allow the Obama administration to save face and say "look, China made a concession" which the teleprompter will explain is an indication that the Obama administration now has the upper hand in Sino-US negotiations, followed by a round of applause from yet more to be soon unemployed people.

Permabull Jim O'Neill of Goldman Sachs surprises everyone by issuing yet another missive after being dead wrong on the Renminbi a month ago, and very vocally so. The surprise is not in his persistent frothiness (the man is a singularly male version of an undoubtedly female A. Joseph Cohen after all), or his attempt at mea culpa'ing (we wonder what sport instrument Roach would recommend using on Mr. O'Neill), but that Jim is still at Goldman after the entire Red Devils fiasco. Oh, and speaking of sport, O'Neill joins the Krugman-Schumer team in providing most unwelcome policy advice to China.

Just a headline from Reuters for now:

U.S. SENATE BILL TO BE UNVEILED TUESDAY THREATENS STIFF PENALTIES ON CHINA IF IT DOES NOT REVALUE ITS CURRENCY-CONGRESSIONAL AIDES

We are confident China gets Reuters too.

The dollar’s status as the world's preferred reserve currency has come into question amid a ballooning budget deficit that keeps the U.S. dependent on foreign financing. It is now a matter of "when" rather than "if" the Chinese yuan will replace the U.S. dollar as the global reserve currency.

China recently raised the Reserve Requirement Ratio by 50 bps to 16.5% for its domestic banks. This is the second hike in the past month and certainly not the last as China’s economy is still sprinting ahead. While equity markets have begun to price in the risk of “global exit strategies,” currency markets have yet to consider the implications of continued strong underlying growth in China. It is likely that additional Chinese monetary tightening will be accompanied by pressure to revalue the yuan.

How the Middle Kingdom Became the World’s Largest Exporter. Is it possible that Obama’s stimulus program is reviving China’s economy more than our own? A free floating Yuan today would be at least 50% higher than it is today.
(CYB)

When big shots at Goldman start talking I listen. I was surprised at what they said today