International | Oct 25 2007
By Chris Shaw
In 2005 when the Chinese yuan or renminbi was allowed to fluctuate in value against the US dollar it was estimated to be around 17-24% undervalued against the greenback and despite two years of gains Danske Bank suggests a similar level of undervaluation still exists today.
In other words the bank suggests the benefits of allowing the currency to gradually appreciate against the US dollar have been limited at best, which is helping drive market speculation of an impending one-off revaluation.
Such a move makes sense to Danske Bank as in its view the current undervalued level of the currency is creating structural issues for the Chinese economy, as with excess returns on the yuan soaring this year as the Chinese business and interest rate cycles have de-coupled from those in the US money is flowing into China and adding to the existing problem of too much liquidity in the economy.
To date the Chinese government’s primary method of dealing with such excess liquidity has been to tighten bank reserve requirement ratios, which have almost doubled over the past year or so to around 13.5%. According to Danske Bank they would have to go further, possibly to as high as 20%, to deal with the liquidity being created by the current capital inflows.
The solution then may be to make a one-off revaluation of the currency, so reducing the amount by which it is undervalued against the greenback. Such a move makes sense also to Jim Rogers, the famed investor who picked the start of the commodities boom back in 1999.
Speaking at an ABN Amro conference in Amsterdam this week Rogers said he was in the process of shifting all his assets out of US dollars to re-invest into the Chinese currency and commodities.
He suggests the US Federal Reserve is eroding the value of the US dollar with its policies, meaning it is unlikely to forever remain as the world’s central currency. This implies significant downside, as he notes when the British pound lost its place as the world’s reserve currency it eventually lost around 80% of its value.
With China emerging as one of the world’s leading growth engines he expects the yuan to continue to strengthen, expecting it could triple or quadruple in value over the next decade. He has also been buying the Japanese yen and the Swiss franc in the expectation that at some point in the future the carry trade will be unwound, meaning these currencies should appreciate as investors reverse short positions.
Rogers remains bullish on commodities and likes the precious metals in particular, having exposure to gold, silver, platinum and palladium. Of these silver is his favourite as it is currently trading at around 75% of its value of 1980 while in comparison equity markets globally are at or near record highs.
Before rushing out to buy the Chinese currency investors should note Danske Bank doesn’t expect an imminent revaluation, as the current financial environment doesn’t really support such a move right now and Chinese policymakers are unlikely to make such a decision prior to a cabinet reshuffle following the recent Communist Party Congress.