As every kitchen sink appears to have a definitive opinion on the impact on the CNY rebalance, we would like to step back for a second and present a historical chart of the country's trade balances not only in total, but by individual country. As the chart shows, and as David Rosenberg also highlights, providing a blanket summary as to the impact of a CNY revaluation is a rather foolhardy thing: while China may enjoy a positive trade surplus with the US and EU, it certainly has a trade deficit with some other key producer countries, namely Korea ($61 billion LTM), Japan ($47 billion), Taiwan ($79 billion), and Australia ($27 billion). So while it could be argued that the US and EU's manufacturing sectors benefit from a stronger Yuan, what happens to the exports of the traditional Chinese partners? Absent the PBoC going full tilt and scaling up its imports across the board, there will be some very unhappy traditional Chinese trade counterparts. Although in this age, when even presumably smart economists beckon to "Spend now, save tomorrow", why bother with something as simple as the Capital to Current account equality. China should buy up everything, and use reverse money or something to then reinvest the reverse proceeds from all the exports into sovereign bonds... or something.
China total monthly trade balance...
And by country:
China-US trade balance:
China-EU trade balance:
In other words, please do not trust anyone (to be politically correct) who will tell you with certainty how this policy change by China will turn out.
Here is David Rosenberg with some more cautious language on having a dogmatic interpretation of the CNY reval (with the undertheme that the move is not as UST bearish as MS will have you believe).
In what is widely being described as a brilliant political gesture ahead of the G20 weekend summit in Toronto, China has announced its intention to sanction a gradual revaluation of the yuan (back to a “crawling peg”). Details pending but most China experts are looking for 3-5% appreciation on an annual basis – the currency has already firmed today to a 20-month high and the U.S. dollar is also trading at a four-week low against the euro.
In turn, this will help to ease global trade imbalances, ward off the threat of trade protectionism, alleviate domestic credit strains and inflation pressures and accelerate the Chinese shift from export-led to consumer-led growth. It also suggests that the Chinese authorities have confidence over the sustainability of the global recovery.
Rough estimates show that every 5% yuan appreciation trims the U.S. trade deficit by just over $60 billion (so it would take something like a 35% appreciation to eliminate the gap altogether – call us in 2020).
The Chinese move has ignited a rally in risk assets to start off the week -- a rally of sizeable proportions. Global equities are riding a 10-day winning streak, the longest in eleven months, led by a 2.8% jump in the MSCI Asia-Pac index. These countries, along with several Latin American nations that compete with China are winners here. Emerging markets soared 2.5% and up nearly 10% from the lows of two-weeks ago (Chinese banks and property shares ripped overnight). European marts are now up for a ninth consecutive day -- also the longest in 11 months. Gold has hit a new all-time high this morning (the news that Saudi gold reserves are twice as much as previously estimated is adding a further thrust to bullion this morning) and both oil and copper are bid as these hard assets priced in U.S. dollars gain ground from the resulting decline in the greenback. The once-parabolic chart of the DXY has reversed course and is now about to test the 50-day m.a. of 84.7 for the first time in three months.
Meanwhile, the safe haven of government bonds has lots of allure as long-term yields back up in response and offer up another opportunity for the Treasury bulls to re-load. CDS spreads are also plunging as investors turn their attention away from the global debt challenges, which most assuredly have not gone away just because of improved Chinese FX flexibility. The view that China will be “recycling” fewer dollars is a tad strange because if the U.S. current account deficit shrinks, as it should, then we are not going to need funding in any event. The capital account and the current account have to balance so these oft-stated remarks that the rise in Treasury yields will be sustained misses two facts:
First, China has not added anything to its hoard of U.S. Treasury securities since June 2009. In fact, it has run down its holdings by a modest amount. Guess what? The yield on the U.S. 10-year note has dropped 40 basis points, to 3.3% over that period. Go figure.
Second, let's recall when China last made such a dramatic announcement with regards to the FX market, which was back on July 21, 2005 when it first moved away from the dollar peg, the consensus view then was similar: buy risky assets, sell the U.S. dollar, secure inflation protection, unload your Treasury position. In the immediate aftermath of that announcement, we admittedly had a knee jerk reaction where Treasuries and the U.S. dollar sold off and commodities and equities rallied in tandem. Over the next three years (the revaluation was terminated in July 2008), here is what happened:
The DXY did indeed go from 85 to 70, but … China’s holdings of U.S. Treasury securities never did go down – they went up to $550 billion from $300 billion.
During that three-year yuan revaluation, the yield on the 10-year T-note fell 80 basis points to 3.7%. The S&P 500 went from 1,230 to 1,260 so it was basically flat. In fact, the total return in the Treasury market more than doubled that of the equity market. And, the VIX index in that three-year period soared from 10x to 25x and had yet to come close to peaking out.
So the only correct call by the intelligentsia in the summer of ‘05 was that the dollar did continue to lose ground. In the final analysis, looking at that entire three-year period of Chinese currency revaluations (and since!) the primary trend has been lower bond yields and lower equity valuation. This was not being predicted in July 2005, and it not being predicted today.
Let’s finish off by saying that at the time, the initial Chinese revaluation was being billed as this huge “reflationary” event. Meanwhile, the core inflation rate sits today at 0.9% compared with 2.1% back then, and the headline rate was over 3% then whereas it is 2% on the nose today. It goes without saying that not even Chinese initiatives in the FX market, no matter how much they can dominate the headlines as is the case today, ultimately proved to be no panacea against a collapse in the U.S. credit and housing markets, deflationary pressures, a huge global recession and a European sovereign default crisis.
Let’s not take our eye off the ball. The global deleveraging cycle is still in full swing, is an intensely deflationary development, and as much as the Chinese revaluation will at the margin help to ease global trade imbalances, it very likely will prove to be every bit the antidote it wasn’t when it first moved to a crawling peg a half-decade ago.