2010/05/22

La cigale et la fourmi: CNY/USD revisited

Time to revisit the "Yin and yang of the greenback" theory.  The theory, regarding the relative value of Chinese and US currencies, is basically "La cigale et la fourmi", not as a moral story but as basic economics. China, the ant  in our parable, has spent the last 25 years working hard and, thanks to government policies that amount to forced savings, not consuming that much.  Meanwhile, the US, the cricket, has spent the last 25 years living off  its charm and beauty as the most advanced economy in the world. Its currency's status as world reserve currency gives it a free lunch in terms of being able to borrow.

At some point, the ant will be tempted  to start "cashing in", converting all that past hard work into a higher standard of living.  How? Well there are several ways the government can convert those savings it has accumulated in USD into benefits for consumers. It could subsidize imported goods like fuel for example. Or more generally, it could let the exchange rate of CNY/USD rise, which would make all foreign goods cheaper in China.  So that's the fundamental thesis, which is not at all an original point of view.  The question was (and still is) when will this play out?

The financial crisis of 2008 looked to me like it was going to be the perfect opportunity for them.  Because it added a couple of other factors (increased US deficit, and the rich world's reduced ability to import from China due to a recession) that added more pressure for the Chinese currency to rise. As it turned out,  rather than shift gears into the next phase of development, one with less reliance on exports and  increased domestic consumption, they decided to stay in the same gear and press on the accelerator instead: they maintained the exchange rate quasi-frozen and stimulated exports even more.  So the big jump in CNY/USD has been postponed.

But will it occur? I still think so. The reserves are still accumulating. Here's the picture I cited last time, Foreign Holdings of U.S. Securities


Country or category
Total
Equities
Long-term debt
Short-term
ABS
Other
debt
1
Japan
1,197
220
133
768
76
2
China (Mainland)1
922
29
217
653
23
3
United Kingdom
921
421
160
316
24
4
Cayman Islands
740
279
236
186
38
5
Luxembourg
703
235
104
320
44

And here is what we have two years later, in the latest report just released last month:



Country or category
Total
Equities
          Long-term debt
Short-term




ABS
Other
debt

1
China (Mainland)1
1,464
78
360
866
160

2
Japan
1,269
182
136
883
69

3
United Kingdom
788
279
64
422
23

4
Cayman Islands
650
227
140
210
73

5
Luxembourg
578
137
49
312
80


Even more of the same! The pressure keeps building....

Moreover, the rumours are that China might have stimulated itself into a bubble of it's own. How does that affect our theory? You face a bubble, and you had a pile of foreign reserves.... Well that's like being in the kitchen with toast almost burning and a huge reserve of nutella. Pop the toaster and enjoy the sandwich, China!

Update: Note that in the above tables, the amount of Chinese holdings of US securities increased a lot both in absolute and relative terms. Also, I should point out one more argument in the same direction: that western policy makers are increasingly calling on China to strengthen CNY.