Focus on the Chinese Currency, Not the Equity Market

Chinese equities have started the new year with a series of implosions, implosions exacerbated by the authorities’ ham handed attempts to dampen volatility. Despite the sound and the fury, the Chinese stock market is a sideshow. Ownership of Chinese equities is low, both in China itself and in the rest of the world.  The renminbi (CNY) exchange rate is a better indicator of what might be going through the minds of policy makers with regard to the real economy.

The Chinese authorities have set the reference rate for the CNY lower for most of the last few weeks.  This has spooked the Chinese equity market and the rest of the world. There seems to be a fear that China is turning away from rebalancing its primary economic driver towards domestic demand and back towards export driven growth. This may be a wish to “dance with the one who brung you“, to go back to what they believe made them successful.

CNY Jan 2016

It makes sense from that perspective, because it’s what they know and what generated a huge amount of employment in the last 15 years. It won’t work due to a lack of demand in, and stiffer competition from, the rest of the world. China must look within, as they had been doing.  It will just take longer to make the domestic economy the primary driver of growth than it did to build an export machine.

China’s growth rate accelerated sharply after its accession to the WTO in December 2001. Much of this growth was built on cheap manufacturing capacity. That capacity was founded upon an influx of low cost labor from the countryside to the cities and an inexpensive exchange rate.  Neither is true today, no matter what your congressman says.


The CNY is, on an inflation adjusted basis, 30% stronger than when China joined the WTO in 2001 and 60% higher than in 2004. Adding insult to injury, the tie to the USD has prompted a 15% rise since May 2014.

What is worse is that China’s manufacturing competitors have improved their positions over the last 10 years as China’s has deteriorated. Mexico is close to the US (and far from God), its cost profile has improved and there is less of a propensity to pirate intellectual capital.  Similar things can be said of Poland relative to Germany.


As far as the currency and its peg go, there are issues revolving around monetary policy that are also pushing China in the direction of a weaker CNY. I covered them here.


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