After nearly two years of currency stability, I believe we are growing closer to a new round of yuan appreciation. And considering that the most frequently asked questions I receive from subscribers are when and how much the Chinese yuan (or renminbi) will appreciate against the U.S. dollar, followed by how the currency appreciation will impact our China Strategy portfolio, I’d like to dig deeper into the issue.
When Beijing allowed the yuan to float in summer of 2005, the currency appreciated nearly 20% against the U.S. dollar to 6.8 yuan per dollar in just three years. However, as a result of the global financial crisis, China’s export sector began to slump in the summer of 2008. So in order to help stimulate exports, Beijing decided to halt further appreciation of the yuan.
But during the recession last year, budget conscious U.S. consumers bought more low cost Chinese-made goods. As a result, China overtook Germany as the world’s top export nation.
No surprise then, that during the past six months, China’s export sector started to recover along with the global economy, and market pressure increased for the yuan’s rise to resume. Recently several U.S. political leaders have applied pressure on Beijing to let the yuan appreciate against the dollar, but senior officials in Beijing have not been willing to succumb to the pressure. China has stated that the yuan will rise only when it is in the country’s best interest to do so and that, for now, it was best to let the dollar-yuan exchange rate remain stable.
But things are about to change.
China Currency Tensions
On April 8, after visiting India, Treasury Secretary Timothy Geithner made a last-minute detour to Beijing. Awaiting Geithner at the airport was the Chinese vice premier and economic czar, Wang Qishan. The two senior finance officials met behind closed doors for 75 minutes and then Geithner flew back to Washington. Many currency market observers, including myself, believe that this meeting may be a precursor to the next wave of yuan appreciation.
It is likely that the two sides agreed upon a near-term timetable for yuan appreciation during the meeting. Supporting this, the following week the Obama administration declined to label China as a “currency manipulator” in a formal report put out by the Treasury.
I think there is a good chance that we will see the yuan (also called the renminbi by forex traders) start to move up again sometime in the next three months. Afterward, I expect to see another gradual multi-year trend in the dollar-yuan exchange rate. I believe that the yuan could appreciate 20% against the dollar to 5.66 yuan per dollar within two to three years.
If my forecast holds true and the yuan rises another 20% against the dollar during the next three years, we will see strong growth in Chinese domestic consumption. And in 10 years, the yuan could appreciate 100%, or double its value, against the U.S. dollar.
With a stronger yuan, Chinese consumers will gain greater wealth and purchasing power, stimulating domestic spending in China. If that happens, I expect to see Chuppies overtake U.S. Boomers as the world’s biggest spenders by the end of the decade.
Three Important Results of Yuan Appreciation
Although the average household income in China is still low, looking at the averages can be misleading because of the nation’s large population. Taking a slightly different perspective, the percentage of Chinese with meaningful spending power — the Chinese middle and upper classes — has more than doubled in the past five years, jumping from 5% of the population in 2006 to 10% today. That equates to more than 130 million people, greater than the population of Japan and with higher purchasing power, given that things cost much less in China than in Japan.
Wealth creation has been even more startling at the top of the country’s social economic pyramid. Thanks to a combination of rising currency, appreciating property values and higher income, the number of U.S. dollar millionaires in China has more than tripled in the past four years – from 350,000 back in 2006 to well over one million today.
There are three important trends that will develop when the Chinese yuan does appreciate sharply against the U.S. dollar.
1.) China will buy more assets, particularly natural resources, abroad. During the past year, China has been buying large amounts of mining and energy assets throughout the world. With a stronger yuan, China will be able to buy much more with their money. This will likely bid up prices of important commodities that China uses, such as copper, iron ore, oil and gold. One such investment to play this trend is the SPDR Gold Trust (NYSE: GLD).
2.) Chinese domestic consumers will sharply increase their expenditure. The transformation of China from an export oriented economy to a domestic consumption based economy will accelerate. In the past year, China’s retail sales increased a whopping 24%. When Chinese consumers greater purchasing power from their yuan, they will spend even more, further driving the Chinese economy. Companies that cater to domestic consumers — such as China-Biotics (NASDAQ: CHBT),a pro-biotic food supplier in China — will benefit from China’s increasing domestic consumption and the rising renminbi.
3.) Assets denominated in Chinese yuan — such as stocks and real estate — will rise sharply in value. Most sectors in China, outside of exports, will gain as their assets become more valuable. We saw this strong currency appreciation happen before in Japan and Taiwan during the late 1980’s, creating immense paper wealth for stocks and properties in both economies. In fact, the Taiwanese stock market rose 1,500% between 1985 and 1990, and property prices more than tripled during the same period. As a result, many Taiwanese from my father’s generation increased their wealth significantly in those years.
The Chinese real estate market is already up significantly, and I expect the stock market to play catch up. I am very excited about the coming rise in the Chinese yuan. The appreciation will create incredible wealth for investors in China.
