More on China currency revalution

Yuan moves show a confident China

Fourth, the yuan’s revaluation opens up a new era of more active Chinese business activities in the world. The old currency system forced Chinese companies to pay more for imported oil, iron ore, and other products. A stronger yuan, while not necessarily decreasing trade imbalances with the US and EU countries, will help foreign companies compete with an avalanche of low-cost Chinese goods. But it will also make foreign assets cheaper for Chinese buyers, possibly prompting more takeover bids by Chinese companies like those launched recently for US oil company Unocal Corp and appliance maker Maytag Corp.

It looks to me like there is potential for this to weaken the dollar against all currencies. As the Chinese central bank has less reason to buy US Treasuries, I don’t expect the effect to be limited to the yuan (or the renminbi depending who you ask). Given that a chunk of the oil price runup is due to dollar weakness, that’s only going to increase dollar denominated oil prices more.

A stronger Chinese currency also means, as noted in the quote, that the Chinese can buy all those imported raw materials and capital goods, like oil and technology products, cheaper, so it may not reduce their growth as much as expected or reduce their own demand for oil at all. It actually makes them more competitive in those markets where they are net importers, which are mostly markets for inputs for their industry.

All things considered, I’m not sure that intervention in currency markets is likely to make much difference in medium to long run equilibrium. The various markets , from equities to bonds to commodities, all have the information about underlying realities available to them and make adjustments for unrealistic currency supports. Currency intervention may make short term differences, but more than anything is bound to just create market inefficiencies that have to be corrected to reach the equilibrium the markets expect. To the extent that the Chinese action is one of moving towards accepting the underlying realities, it’s a good thing and generally speaking that means more growth for all the parties involved. What’s it mean for commodities prices? That’s complicated, because it could have positive and negative effects on the demand for commodities, but I suspect it’s effects will be muted by the various markets’s anticipation of some kind of adjustment.

Kevin Whited at PubliusTx emailed me the article and asked my thoughts.

More on oil and currency markets on my site Financial Options including The Secret Way to Play Oil.

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