Will China allow its currency to appreciate?
April 18, 2005
Central to the thesis that the gold price will continue
to rise on the back of a falling US dollar, is the premise that
China will forego its policy of supporting the dollar in favor of
letting its own currency, the renminbi, appreciate. Both China and
Japan are accumulating massive amounts of dollars as a result of
their trade surpluses with the United States. But instead of selling
those trade dollars into the foreign exchange markets, they, and
other countries, are hoarding the dollars and investing them in
US Treasury securities. As a result the US dollar is currently trading
at a much higher exchange rate than it should versus the renminbi,
the yen, other Southeast Asian currencies and, in fact, most currencies.
Many people have argued that China will not allow
the renminbi to appreciate against the dollar because it needs US
consumption to drive its fledgling economy. But pressure is mounting
from Europe, the United States, the World Bank and the IMF for China
to let its currency appreciate.
The contention is that Chinese exports have an unfair
advantage in the world because the renminbi is undervalued in foreign
exchange markets. The undervaluation is a direct result of China’s
dollar-hoarding policy, since it keeps the trade dollars that China
receives every day off the market.
Support is growing in the US Senate for taking tariff
action against China. The US trade deficit with China totaled $29.12
billion for only January and February of this year. That is a fifty
percent increase from last year. The US trade deficit with China
is now the largest of any country and almost double the size of
the trade deficit with Japan, which is second.
The appointment of a new US trade representative is
being blocked until Senate leaders vote on anti-subsidy laws against
non-market economies such as China. In addition, a wide coalition
of senators is backing legislation to impose a 27.5% tariff on all
Chinese products entering the US if Beijing does not agree to raise
the value of its currency.
If China does not allow its currency to appreciate
against the dollar, and if the US goes ahead and implements the
tariffs, all Chinese goods will become 27.5% more expensive for
US consumers. On the other hand, if China allows its currency to
appreciate, let’s say by the same amount, 27.5%, then its
goods would be no more expensive to US consumers than if tariffs
were imposed. However, the cost of all China’s imports would
fall by 21.6% if it allowed its currency to appreciate by 27.5%.
So what do you think China is more likely to do? Give the US government
a revenue stream equal to 27.5% of the value of all Chinese imports
to the US, or reduce the cost of its own imports by 21.6%?
The Chinese have always struck me as intelligent and
practical. I suspect that China is going to let its currency appreciate.
This not only means that the US dollar is going to fall, it also
implies that US interest rates are going to rise because if the
Chinese (and Japanese) no longer have to keep their trade dollars
off the market to prevent the US dollar from falling they will also
not need to buy as many US Treasuries as they have in the past.
It’s all starting to come together. The next
big upward move in the gold price will occur when China and Japan
allow their currencies to appreciate and the dollar to fall. I have
no idea whether it will be this year, or next, but I do believe
the current decline in gold and gold related equities represents
I’ll be speaking at next month’s investment
conference in New York. Visit my website www.paulvaneeden.com
Paul van Eeden
Paul van Eeden works primarily to find investments for his
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