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Our leaders
want a weaker dollar and a stronger Chinese renminbi
(RMB). That's our assessment based on recent comments by President Obama,
presidential hopeful Romney and Federal Reserve (Fed) Chair Bernanke. If you
join them in that call, OK, just be careful what you wish for, or at least
consider taking action to protect your portfolio.
In the past
few weeks, Bernanke has become ever more vocal in encouraging emerging market
countries to allow their currencies to appreciate against the dollar; and
Obama and Romney have both been advocating for a weaker dollar versus
specifically the Chinese RMB. In the recent presidential debates Romney
continued his call for declaring China a currency manipulator, and Obama
proudly stated that the RMB had appreciated 11% against the dollar since he
took office. It has actually been about 9% according to the data we look at;
nevertheless, the point that both were clearly trying to make is that a
weaker U.S. dollar is in our economic best interests. Likewise, in an IMF
speech Bernanke essentially admitted that accommodative monetary policy
in the U.S. causes upward pressure on foreign exchange rates between emerging
market currencies and the dollar, and suggested that foreign central banks
allow that dollar depreciation to take hold, rather than intervene to prevent
it.
It may be
superficially plausible that RMB appreciation is the key to alleviating our
economic woes, by promoting exports and therefore jobs in the U.S. However,
while lowering one's currency might give a boost to corporate earnings for
the next quarter (as foreign earnings are translated into higher U.S. dollar
gains), it is difficult to imagine that the U.S. can truly compete on price -
the day we export sneakers to Vietnam will hopefully never come. An advanced
economy, in our assessment, must compete on value, not price. Without
discussing the merits of this argument in more detail, let's look at the flip
side of a stronger RMB, which is a weaker dollar and potentially higher
prices for goods imported from China. Notice that there is a lot of table pounding
about China stealing manufacturing jobs, but no protest when it comes to the
low prices consumers enjoy as a result of China trade. After all, not all
Americans are producers of export goods, but certainly all are consumers of
goods in general, many of which are imported from China and emerging Asia.
Even if we
accept the argument that a weaker dollar may be good for certain sectors and
perhaps for the U.S. economy at large, not all will benefit, in particular,
not retirees facing diminished purchasing power. Retirees would not see the
nominal wage increases that the active labor force could expect to
experience, meaning rising costs of living without an offsetting rise in
income, which may only be coming from a fixed-income portfolio still earning zero
interest as Bernanke has made it clear that "policy accommodation will
remain even as the economy picks up."
We agree with
our policy makers to the extent that the dollar may be generally overvalued
and many Asian currencies undervalued; and therefore the path of least
resistance may lead to Asian currencies grinding higher across the board. The
below chart illustrates this trend. China's appetite for currency
appreciation against the dollar may have a good deal to do with its
currency's relative strength or weakness compared to its Asian neighbors, who
are export competitors. As these other Asian currencies appreciate they
provide the RMB more room to appreciate as well.
While many
Asian currencies may rise over the coming years, we think Asian countries
like China, that are moving up the value-added
chain, are in a better position to handle more rapid currency appreciation
than others. As production processes become more complex, it is harder for
low-price competitors to easily replicate that output. As such, higher
value-added products provide China's exporters with greater pricing power in the
global market, limiting the need and effectiveness of a cheap currency
policy. Additionally, over the medium to longer term, as the Chinese economy
continues to grow and the middle class becomes wealthier, domestic
consumption will play a larger and larger role in their GDP, and that shift
away from economic reliance on the American consumer will also diminish the
need for an export oriented currency policy. In fact, we believe a stronger
RMB will be beneficial for the Chinese consumer and help that transition
along.
The gradual
shift towards greater domestic consumption is occurring in many other Asian
countries that have been following the export growth model and, as Bernanke
puts it, that "systematically resist currency appreciation." As we
can see in the above chart many Asian currencies haven't
been resisting appreciation as much as you might think, and this gets
to Obama's point on the RMB appreciation since he took office. From an
investment standpoint, 9% in four years isn't a bad return in this environment;
it would take over 78 years to reach that return rolling 3-month T-bills at
their current yield of 0.11%.
American
consumers (and Chinese exporters) have been subsidized by the artificially
weak Chinese currency, to the detriment of Chinese consumers who have faced
stunted purchasing power. However, we believe this dynamic will continue to
change and suggest that a stronger RMB is very likely not only on Bernanke,
Obama, and Romney's wish list, but increasingly in China's own interest. That
would mean the tables getting turned on the American consumer.
By the way,
there is a good reason no President has called China a currency manipulator.
Once China is labeled a currency manipulator, it sets in motion a process in
which Congress takes up the matter. Without going into detail, our recent
Presidents have preferred to seize rather than delegate power: by calling
China a currency manipulator, the President would essentially tell Congress
to have a stab at the issue; whereas the President has far more flexibility
at the executive branch in dealing with China without consulting with
Congress. Once Congress gets involved, the threat of a trade war does become
more likely. Even if Romney is correct that China may have more to lose in a
trade war, our analysis shows that the currency of a country with a trade
deficit may be under more strain in a trade war. That may well be what Romney
wants to achieve, but again, be careful what you wish for.
If part of
what investors consume is produced in another region, then holding some local
currency or local currency denominated assets may be prudent. American
consumers should ultimately not be concerned with the number of dollars in
the bank, but rather with what those dollars can buy in terms of real goods
and services. We suggest that Bernanke may be the currency manipulator to be
more afraid of, and moreover, that our de-facto weak dollar policy may be
reason to take the purchasing power risk of the dollar into account.
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