‘Everyone’s mad at China... and they may stay so for long

Frustration over China’s unwillingness to allow its currency, the renminbi, to appreciate meaningfully against the US dollar — which is cannibalising exports and growth from other economies — is mounting not just among “the usual suspects” in Washington but also Japan and Europe, say economists and analysts.

“Patience with China may be running out, and this comes at the risk of mounting protectionism,” cautions Societe Generale analyst Michala Marcussen.

“The yuan has gained less than 1% against the dollar since China officially de-pegged its currency on June 19. Over the same period, the yuan has depreciated by 1.5% against the euro and 7% against the yen.”

Chinese action — or, rather, inaction — on the currency front is “politically provocative,” says CLSA Asia-Pacific Markets equity strategist Chris Wood here last week. “The Chinese haven’t let the renminbi move very much.”

And, worse, some economists now suggest that China could, in fact,  revert to the dollar peg if, as is expected, the US opts for another round of quantitative easing to stimulate its economy.

“If the US Federal Reserve goes back to quantitative easing, the dollar will depreciate against the euro and most other currencies,” points out CLSA’s head of thematic research Eric Fishwick.

In such a scenario, if China were to deliver on its promise to manage its currency against a trade-weighted basket, one could expect to see the renminbi appreciate against the dollar.

“But I don’t think China will… I think authorities will peg the exchange rate back to the dollar - and they’d use the same justification as they did the last time: that they’re acting in the interest of stability of the global financial system,” said Fishwick.

But discontent over China’s mercantilist currency policy is brewing not just in Washington, but in Japan and Europe, points out Marcussen.

“In Tokyo, discontent with China’s apparent newfound appetite for yen-denominated securities is apparent.” China purchased $7 billion of Japanese assets in July, and although that’s still small in absolute terms, “there is concern that the move is part of a trend to diversify China’s $2.5 trillion of foreign exchange reserves assets.”

But China’s move in turn is forcing Japanese policymakers to intervene to check the yen’s sharp appreciation.

“It’s amusing,” says CLSA consultant Russell Napier. The Chinese are now buying Japanese bonds, but that will force the Japanese to buy US Treasuries… You can shuffle this around as much as you like, but it’s all going to end up in US Treasuries.”

Marcussen points to similar criticism of China emanating from Europe, where European Union foreign ministers are to meet this week. Although it’s less vocal than the criticism in Washington, “discontent with China is also present in Europe.”   

All this is heightening concerns over protectionism and trade friction, particularly given that mid-term Congressional elections are due in November in the US, where unemployment is running at closes to 10%.

“A lot of members of Congress are arguing that the only reason US unemployment is stil as high is because of the renminbi exchange rate,” notes CLSA China macro strategist Andy Rothman. And although from an economic perspective, there is “no substance to that argument,” it still remains a well-accepted argument in the US, he adds.

“My fear,” says Fishwick, “is that protectionism will flare up as democratically elected politicians who have received a good kicking in the elections will look for some quick-fix.” But such “sabre-rattling” will not stop China from pegging its exchange rate, he reckons.

As economies struggle to secure sustainable recovery, protectionist measures cannot be excluded, notes Marcussen. “If escalated, such an outcome could prove very damaging to the overall global recovery.”

Wood believes a major trade war isn’t imminent. “I don’t think the economy is as bad as that yet,” he reckons. “But we could well get more concerns like that if things deteriorate.”

It doesn’t help that discontent with China isn’t going away anytime soon, adds Marcussen.