If China was simply a medium-sized country, the world could shrug off its currency policies. But it is now the world's largest exporter, the world's largest manufacturer and its second-largest economy. And yet it is the only major trading nation to use capital controls to prevent its currency rising to market levels. It is that anomaly that is at the heart of current global economic tensions.
Even the Americans are not asking China to move to a fully-convertible currency overnight. The country's banking system is probably still too unsophisticated to cope with the flows of "hot money" that would generate. But the rest of the world does have a right to expect China to allow its currency to rise faster - and to set a time-frame to move to market-determined exchange rates.
Yet when I made that suggestion to a group of Chinese academics in Shanghai last week I got a distinctly frosty response. If China let the level of the renminbi be determined by the markets, I was told, the US would deliberately use its financial institutions to destabilise China. And another thing: if the Americans care so much about their competitiveness, why didn't they just pay themselves wages at Chinese levels?
David Fuller's view This last sentence
above contains a harsh reality: globalisation, the transfer of technology, good
economic governance and hard work has enabled China to catch up very quickly.
China could allow the renminbi to appreciate by 50% against the US dollar and
its labour costs would still be competitive with the USA, although not with
the rest of developing (progressing) Asia.
China's biggest competitors are in its own backyard and parts of South America, and even a small revaluation of the renminbi would wipe out many low-tech manufacturers who operate with razor-thin margins. China needs time, during which more of its manufacturers move to higher-end products. However this will make China even more competitive with the West.
The reality is that standards of living are declining in the West and rising in Asia. There is still a long way to go before a more level playing field in terms of manufacturing costs is achieved.
Meanwhile, US pressure on China over its currency, which is gradually rising against the US dollar (shown in reverse, USD/CNY), is likely to remain counterproductive. It would make more sense for the US government to encourage Chinese and other foreign companies to open manufacturing centres in America. Simultaneously, good economic governance should eventually reverse the outflow of manufacturing from the USA.
What about investment prospects in these markets?
For China, I am wondering if we are moving into an environment similar to 2006. Supply problems for Shanghai's Composite (A-Shares) Index are drying up and historic valuations remain cheap. The overall pattern looks like an extended base formation. China's Shanghai B-Shares Index continues to race ahead.
Most westerners buy China via the Hong Kong Hang Seng Index and the Hang Seng China Enterprise Index. The former has completed its lengthy consolidation and is unlikely to see more than a brief pause before extending gains towards the 2007 peak. A fall back beneath the now rising MA would be required to significantly delay this outlook. HSCEI has paused near its November 2009 high and would also have to fall back beneath its MA to delay substantially medium-term scope for a rally closer to the 2007 peak.
I favour an overweight position in China, which has some of the best valuations in Asia, after Vietnam which remains unloved because of its currency devaluation but is now a recovery candidate. My main personal China investments are in the Atlantis China Healthcare Fund (ATCHLTH ID), despite its high costs. I also hold the iShares FTSE/Xinhua China 25 tracker (FXC LN), which is just beginning to perform. Lastly, I have a position in China Mobile (HK 941) which was not helped when Vodafone sold its holding a couple of months ago. Nevertheless China Mobile has a promising base formation and currently yields 3.5%. A Chart Library Search under 'China' will produce many more funds and ETFs which invest in China.
Taking a medium to longer-term view, I am likely to increase my very small and currently underwater stake in the db x-trackers FTSE Vietnam ETF (XFVT LN). It currently sells at a historic PER of 10.71 and yields 2.51, according to Bloomberg. I can't speak for the Vietnamese government but my guess is that their devaluation is mostly over. When investors sense this, the Vietnamese stock market should take off in a catch-up move. Patient investors may prefer to buy when it is cheap.