China Currency Dwindling Fast

For a long time, China’s currency was pegged to the US dollar. In fact, China’s currency has been pegged since 1994. The general reason to peg exchange rates is for trade. Importers and exporters have a much easier time knowing what to expect for their transactions. Pegging can also make exporting prices more competitive. China is the biggest exporter in the world. So it makes sense to keep the price of the yuan low.

However, since the Chinese central bank devalued the yuan in August last year, it has been depreciating rapidly. The change in China’s exchange rate policy was aimed at giving the market a bigger say on the value of the yuan.

The graph below shows resulting exchange rate policy change by China.  The blue line shows the US$–yuan.

USD Yuan Feb 2016

Source: Bloomberg

Chinese currency on a one way trip

The Chinese currency was overvalued, and some think it still is. Further depreciation is expected to hinder China’s investments. Several major hedge funds have also piled into bets of a declining yuan. The biggest of which might be George Soros, the man who broke the bank of England (BoE). Last month the People Bank of China (PBoC) urged Soros not to get involve in the selling down of the yuan.

But even if Soros doesn’t participate, there will be billion dollar hedge funds lining up to create their fortune on the FX markets. US-based Hayman Capital Management is one such company to join the speculation. They have invested a huge amount, 85%, of their portfolio, in short positions on the yuan. And Hayman is definitely not the only one.

The selling reflects multiple things going on within China. Their economy is slowing down, and it could be the only sure bet in such unstable financial markets. Capital flowing out of China is also contributing to the yuan’s decline giving traders more confidence to get into short positions.

The above factors are still persisting. If you had to bet, wouldn’t you go where the smart money is? But let’s focus a little bit more on capital outflows.

Capital flowing out of China is a growing concern. Chinese investors are looking to diversify assets overseas, putting downwards pressure on the yuan. It’s estimated that US$760 billion of capital was flowing out of the country last year. Yet it could get even high this year.

Some are expecting capital outflows to total US$911 billion. Just the idea has put China on full alert, imposing strict capital controls on their citizens. So what does this mean? It will be harder for Chinese investors to place their money in foreign investment. Therefore less spending abroad.

Japan was one of the first to suggest capital controls for the Chinese economy. Of course Japan has a vested interest in the yuan. Why? For their plans to simulate spending and boost growth, Japan depends upon their currency, the yen, to be weak. And Chinese investors are taking their capital abroad to Japan raises the Japanese yen.

So Japan has concerns over how strict China’s capital controls will be. But not all countries want China’s money to stay within their borders. Places like Australia are welcoming Chinese investment as a source of growth and advancement.

Lack of funds could stunt the Australian market

Chinese investors love Australian property. Constant spending into our return-rich market has raised property prices above all others. The graph below shows property growth for various different nations.

Nominal House Prices Finch

Source: Finch rating

It’s easy to see why investors love Australian property. House prices seem to provide greater returns than most equity markets. Sure, property prices are high, but the Chinese know a good investment when they see one.

However, if Chinese capital controls tighten, what would this mean for Australian property? My guess is a minor blip in housing prices. Why? Because developers can’t pass up a good investment.

Nerida Conisbee leads the research team at the international realtors Colliers. She believes, ‘China now dominates in terms of investment into real estate.’ She also referred to Australian property returns being too good to pass up. ‘I think it just comes down to their investment metrics and perhaps the comparison of returns elsewhere,’ she said.

Chinese investment has definitely come a long way. China only committed $2.3 billion into Australia real estate as of 2010. But today, Chinese investors put as much as $12.4 billion into Australia’s property sector. That is more than double the amount invested into mining. Why would developers look anywhere else than Australia?

Härje Ronngard

Junior Analyst, Money Morning

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