Wednesday, 18 January 2012

US Dollar and Chinese Renminbi / Yuan Currency Appreciation Rate

Today's currency post focuses on the US Dollar and Chinese RMB / Yuan appreciation rate.  As almost everyone is aware, China currently pegs the value of its currency to the USD.  Pre-2008, it was pegged to a basket of currencies but since the Financial Crisis of 2008, its been heavily pegged again to the dollar. 

The implications of this policy is that the CNY can not appreciate to reflect its true value due to the strong capital control the Chinese government imposes.  However, the rules of supply and demand and the nature of the global economic cannot sustain such a price discrepancy for that long.  China recognizes this and is currently undergoing a gradual controlled appreciation of its currency. 

This opens up an opportunity area for those who can invest in Chinese currency.  So lets see what potential rate of returns that this can generate.

The above chart represents the USD/CNY exchange rate since 2006.  There's clearly 3 periods, the appreciation pre 2008 (A), the constant peg of 2008-2010, and the current 2010-2012 depreciation (B).  

For period A, the initial starting value is 8.07 and the end value is 6.8 over a period of 2.5 yrs.  This leads to a average return of ~6.3% per year.  For period B, starting at 6.8 and current value of 6.3 gives us an average annual return of 4.9% per yr.  Since the current period is of obviously higher interest, that also translates to a current appreciation rate of 0.4% per month.

So how does this compare?  The S&P 500 is currently yielding 2%, General Electric (GE) yields 3.58%, Vanguard Total Bond (BND) market yields 3.1%, and iShares S&P U.S. Preferred Stock Index (PFF) currently yields 6.6%.  
So the CNY appreciation rate is comparable and slightly better than many options but not a home run, which is likely China's intention.  However, unlike other currency speculation, there are some benefits here. 

  • China is unlikely to completely remove its USD peg which means if you're using US dollars, you won't have the usual risk of currency devaluation.
  • If there is economic stress, China will likely revert back to a flat peg, limiting your downside.
  • China RMB is clearly overvalued (some guesses vary from 20-50%) so there is significant room for continued devaluation.
  • Rates of return of ~5% per year is good considering the risk.
  • Devaluation rates are fairly constant and predictable.


    • Very difficult to get opportunities to invest in RMB due to China capital control.  Some opportunities are now opening in Hong Kong and other Chinese banks.
    • 5% return per year is good...but not great.
    • Subject to political moves and tension which is typically hard to predict. 

    So final recommendations?  If you have opportunity to invest in the Chinese RMB and are looking for a good constant and relatively safe return rate, it is a good option.  As usual, you should take into account portfolio diversification to prevent yourself from being overly exposed.

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