The Currency Crocodile

The BIS publishes excellent data on almost all the currencies in the world; one of the data sets that caught my eye recently was this one: BIS Effective Exchange rate, CPI based, trade weighted. All currencies have been rebased at 100 in 2010.

.bis-effective-exchange-rate

The countries with the most overvalued currencies (in that order):

  1. Hong Kong
  2. China
  3. Saudi Arabia
  4. US
  5. Korea
  6. Philippines

The countries with the most undervalued currencies (in that order):

  1. South Africa
  2. Colombia
  3. Mexico
  4. Russia
  5. Turkey
  6. Japan
  7. Brazil

There are many themes one can construct just by building on the two tables above but I’ll focus my attention on the Chinese Renminbi, and by extension the Hong Kong dollar.

China’s USD reserves have fallen by nearly 25% in the last two years. The Renminbi has lost nearly 15% in value against the USD in the same period.

china-reserves-usd

All this is happening at a time when China’s trade balance is at an all time high:

china-current-account-analysis

Out of the US $315 B trade surplus in 2015, Goods contributed US $567 B, and Services contributed US $-182 B.

There is, however, a substantial headwind to this trade surplus. A deeper analysis of China’s current account shows us that out of the US $-182 B contributed by Services, US $ -178 B, or nearly 98% comes from one item: Travel.

china-current-account-services

A demographic analysis of china shows us that the ghost of Mao is haunting China, big league. The directionless policies of Mao’s government that led to the chaos of cultural revolution greatly impacted the number of births in China during the late 60s. The subsequent one child policy added to that problem.

china-births-65-year-lag

China is getting old. While the number of 45 year olds has already peaked, the number of 65 year olds is rising and will continue to rise until 2033. There’s one thing retired people like to do more than anything else, travel.

If you are a sovereign nation, and you have one of the most expensive currencies in the world according to the BIS, and you are a net exporter, and you are worried about capital flight, and you are losing your FX reserves trying to support your falling currency, well…common sense seems to dictate that you should just allow your currency to adjust lower until the market finds an equilibrium. My sense is that China has accepted this and is headed there on a slow boat.

bis-effective-exchange-rate

The gap between overvalued and undervalued currencies will close over time, eventually. The currency crocodile will, eventually, snap its open mouth shut. Its not a question of if but when. When it snaps you don’t want to be caught in the middle of it. If China devalues, god save the HKD peg, commodities, and commodity producers.

Merry Christmas & Happy Holidays!