It may be a vote-catcher, but it ain't necessarily so .....

Tuesday 27th September 2016

It may be a vote-catcher, but it ain't necessarily so .....

ref:- "Donald Trump Charges China With Yuan Manipulation -- Again", The Wall Street Journal, Markets / Currencies / Foreign Exchange

How do we know whether Hillary Clinton or Donald Trump was the winner in last night's US Presidential debate? Look at how the Mexican Peso is doing, of course ..... Mr Trump's attacks on the North American Free Trade agreement (NAFTA) and his oft-repeated determination to build a wall along the US's southern border has made the Mexican unit a proxy for the Republican candidate's prospects of election. A Bloomberg poll that put the two candidates on level pegging at 46% had seen the Peso weaken to historic levels (near 20 per US dollar) before the debate, but a small rally in the Peso this morning confirms that in the judgement of financial markets at least, Mrs Clinton took the first round. Mr Trump's supporters will ask "what do financial markets know anyway?" ..... and thinking back to Brexit, they may have a point.

There's a very long way to go and besides, it's not the Peso that the WSJ has been looking at but the Chinese Yuan. Mr Trump lost no time last night in accusing China of weakening its currency to gain an unfair trade advantage. It's a regular rant of his and his campaign website states that the Yuan is undervalued by anywhere between 15% and 40%. Such a position is appealing to a growing number of Americans, particularly those involved in a manufacturing sector that has suffered at the hands of cheap imports  --  a case of populism at work, if you like. The evidence however suggests that neither the accusations of currency manipulation nor of Yuan undervaluation really hold water  --  which may prove to be an inconvenient truth for Mr Trump but is unlikely to change his approach.

The reason why such views sound so credible to many, including other leading US politicians, is that in the past they were absolutely correct. Manipulation, which in simple terms can be described as artificially keeping your currency undervalued to make your exports more competitive, was undoubtedly part of China's strategy when it kept the Yuan pegged to the Dollar for a decade until mid-2005 even though the Chinese economy was expanding rapidly. Even after the peg was scrapped, the Yuan only rose 21% in the years to 2008 despite China's trade surplus in goods tripling.

It's still true that the People's Bank of China does keep a tight rein on currency movements compared to the free market movements usually advocated by other key central banks, and the clamour against manipulation by Beijing was re-ignited by a (relatively small) devaluation in August of last year. But much of the criticism does not stack up. The Yuan is just 2.6% weaker this year despite a sharp drop in early 2016. China has its own worries regarding capital outflows and examination of a 10.5% drop in foreign-exchange reserves reveals that rather than massaging the currency lower, they have been actively supporting the Yuan. One thing they haven't been guilty of is manipulation, according to no less an authority than the US Treasury.

It's too easy for politicians to blame artificial currency rates instead of looking at other fundamental hard truths closer to home. The WSJ points out that the US's goods trade deficit has widened every year of the past forty WHATEVER the value of the Yuan. On top of which, a weaker currency does little good if demand is slack. The Yuan may be weaker this year but US imports form China are down 6.5% so far this year compared with the same period last year  --  if it's all a Chinese masterplan then it's not working too well, is it?

And what about the assertion that the Yuan is undervalued? It's a difficult one in that it's not easy to assess any currency's fair value. One measure is to look at a country's real effective exchange rate, a gauge of  its exchange rates against leading trading partners adjusted for inflation. Compared to its 5 year and 10 year averages, the Yuan is in fact OVERvalued, not under, according to data compiled by the Bank for International Settlements.

One last thought ..... assume for a moment that Mr Trump got his wish for an immediate cessation of PBoC controls over the Yuan. Obviously, he'd then be hoping for a Yuan appreciation that would boost the US's trade position. But there's no guarantee that would happen .... it's perfectly possible that a slowdown in China's economy, a rush of capital outflows and a resumption of upward moves in US rates  for example might combine to weaken the Yuan. Who would Mr Trump blame then? It might be case of being careful what you wish for, and being careful is not Mr Trump's style.