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,
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 an opportunity.
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
own portfolio and shares his investment ideas with subscribers to his weekly
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