The value of China’s currency relative to the dollar is controversial. Congress threatens China with punitive tariffs if it does not weaken the dollar relative to the yuan. Just how this issue will unfold is uncertain. It is likely, however, that Chinese exchange policies will eventually change, and that speculators will play a role.
China clearly acts to suppress the value of the yuan relative to the dollar. Its central bank would not be buying hundreds of billions of dollars per year if that were not the case.
Sopping up dollars in foreign exchange markets does keep the price of the dollar higher than if such purchases did not occur. A higher-priced dollar means that Chinese exports to the U.S. are cheaper — and U.S. exports to China more expensive — than if pure market forces prevailed in foreign exchange markets.
Remember, however, that exports are not the only source of dollars flowing into China. Investors from other countries — including most large U.S. corporations — continue to send substantial amounts of money to build or buy factories in China. Such investment inflows also play a role in China’s dollar glut.
There also are speculative purchases of the yuan. These are hard to estimate, but will grow as expectations of an eventual Chinese revaluation increase. Here’s why.
The current exchange rate is about 8.3 yuan to one U.S. dollar. That means one yuan is worth 12 cents. If China stops buying dollars, the yuan will gain value. Its price might, for example, rise to 15 cents U.S. That would equal 6.67 yuan per dollar instead of the current 8.3.
Take a million dollars today and invest it in China. Buy 8,300,000 yuan worth of Chinese bonds or put it in a savings account. When the yuan is revalued – as you bet it will – those 8,300,000 yuan will yield $1,245,000 at the new rate of 6.67 yuan per dollar. This is not a bad return.
Such speculative purchases of a currency expected to rise in value become increasingly frequent as such expectations grow stronger. Governments can try to limit such speculation but it is impossible to avoid it completely.
The Bank of China may be able to forestall speculative purchases by large investors like George Soros, who made more than $1 billion betting that the British pound would fall in 1992, but they will find it hard to limit such purchases by thousands of ethnic Chinese from Singapore, Taiwan, Hong Kong and elsewhere.
These business people know their way around Chinese laws and financial institutions. They will find ways to cloak currency speculation in the guise of other business activities.
The more outsiders present dollars for yuan at an exchange rate of 8.3, the more dollars the Bank of China must buy to keep the value of the dollar from falling. It will become a vicious circle. Eventually China will have to fold its cards.
© 2005 Edward Lotterman
Chanarambie Consulting, Inc.