Trading up (once again)

I'll be on the road for most of the next two weeks, making stops in Beijing and Tokyo.  I hope to chime in occasionally. I will be working, not vacationing.  But I also will have trouble posting as frequently as I normally do. 

Fortunately, I was able to convince emerging markets/ China guru Michael Pettis (of Peking Universitry and the blog China financial markets) to post here on a semi-regular basis here over the next couple of weeks.   

In his most recent post, Mr. Pettis notes that the RMB's pace of appreciation picked up last week.   That's true, but the rapid appreciation last week came after an extended period when the RMB was stuck at 7.5 even as the dollar was falling. 

China basically sat out the dollar's fall in September and October -- or rather, it opted to follow the dollar down v. host of currencies.  A bit of appreciation against the dollar just undoes some of the RMB's recent depreciation against the euro.

More importantly, as Mr. Pettis notes, expectations of RMB appreciation have picked up.   If the market is right and the RMB appreciates by 7% over the next year, simple Chinese bank deposits look mighty attractive.  Pettis:

If market assumptions are correct and the RMB does begin to appreciate at 7.3%, with bank deposits yielding 3.8% you can earn 11.4% in US dollars if you can smuggle money into China and deposit it in a bank.  Even the most intrepid of my hedge fund friends in New York wouldn’t sniff at those kinds of returns, especially since the biggest risk is upside risk – a sudden maxi-revaluation.  There’s the problem – an obvious danger of speeding up the appreciation rate is that it might set off another wave of speculative inflows, thus pushing monetary conditions even more out of whack. 

Poor PBoC – dammed if they do, damned if they don’t.

I agree.   

Of course, the same forces that make smuggling money into China attractive also make the CIC's job all the more difficult.  It is hard to get a decent return in RMB if you are forced to buy depreciating dollar and euro-denominated assets.  The CIC's effective cost of dollar funds -- if the market's expectations about RMB appreciation are right -- is over 10%.