After spending a busy week in China, I should not be surprised that the most interesting developments in the the global financial markets have happened in China over the past 2 weeks. China has always been an interesting proposition for me. Their culture and habits peculiar as they may be (red wine mixed with 7-UP, drinking 60% alcohol content Baijiu etc), are always of interest for me.
Over the past 10 years, China has come a long way and it has been the "no brainer" investment theme for many investors. A lot of money has been made and lost in the Chinese stock market over the past 5 years, with the Shanghai composite trading up to 5800 points and falling to as low as 1728 points. Thus it is the last market for anyone to describe as boring and uneventful.
Latest news out of China over the weekend was the de-pegging of the yuan from the USD. This has been widely anticipated globally, with all their trading partners (esp USA) shouting murder at the Chinese exporters, this is viewed as a move to appease the G20 countries before their meeting. Not a lot is expected to come out of this de-peg because the Chinese government is not going to allow the yuan to be too volatile and in their statement, they emphasized on stability of the yuan and it is not possible that they will let it fluctuate too freely.
What are the repercussions from this move? First and foremost, it will make the Chinese exports a little more expensive from their current levels but rest assured, the Chinese are not ready to move from an export oriented economy to a domestic consumption oriented one. The move to de-peg is a vote of confidence in the global economic recovery. Finally after 23 months of pegging, the Chinese government finally feels that the global consumers are back to their spending ways and there is no need for them to protect their exporters.
Also, with a stronger yuan down the road, it will give domestic consumers cheaper foreign goods and also curb internal domestic inflation. I will discuss why inflationary pressure will be a problem going forward a little later.
Another interesting development in China has been the wage disputes in the manufacturing sector. It all started with Foxconn, having 8 suicides in their factory. Blaming it all on the low wages, driving them to commit suicide at the factory. Frankly, I think it is a joke that all the suicides are attributed to the hardship of the workers and the low wages that they have to live on. Foxconn was pressured into raising wages in some of their factories by 70%. This may sound like a lot but considering they were only earning less than 1000 yuan per month, a 70% raise is really not a big deal.
After Foxconn set the precedence, workers in Honda and Toyota factories have all gone on strike, pressurizing the car makers to re-adjust their wages upwards. I fully expect this to move to other manufacturers and the minimum wages will be raised across the board in the manufacturing sectors in China. This rise in wages in such a large sector will lead to a wage push inflationary situation. Why do I say that? That is because the "marginal propensity to consume" (MPC) for lower income consumers is much higher than the high income earners.
For the benefit of readers who have not studied economics, MPC refers to the additional consumption per dollar increase in disposable income. For lower income earners, they tend to consume below subsistence levels and as their incomes rise, they will start moving their consumption to move on par with subsistence levels and more. This will lead to stronger demand for basic goods and push prices higher. The Chinese consumer price index is predominantly made up by food and energy prices. With the biggest component being....make a guess....I bet you cannot guess it. PORK.
Hahaha, believe it or not, the Chinese love pork and prices can be expected to rise as more pork dumplings are consumed going forward. hahaha. Do not take this as a buy call for Synear Foods Limited in any way. Anyway, inflation numbers have been coming in higher than expected and going forward we can expect the wage increases to lead to more pressure on inflation. This wage push inflation scenario is something that I feel is very possible but I do not see it written in any of the papers I have been reading in the past 2 weeks. But as usual, by the time this comes out in the papers, the time to invest in the benefiting industries will be over.
The Chinese government's move to de-peg its yuan against the USD is also in anticipation of higher domestic inflation. This will give them an additional tool to cope with the inflationary pressures in the future. Lowering prices of foreign final and intermediate goods will help cushion some of the price pressures. Should prices start to rise too quickly, the government can allow the yuan to rise more, rather than just depending solely on raising interesting rates. I believe the Chinese government is not ready to raise interest rates too aggressively if the inflation picks up and this gives them more room to maneuver.
I believe this is a very good move by the Chinese and it shows they have the vision to anticipate the possible problems in the future. There was a very wise young man that pointed out that this may not be a good thing for China because if the USD depreciates against the yuan, their US$900 billion dollar treasury holdings will fall in price. But I would counter argue that this move will allow the Chinese to limit their losses as they do not need to keep buying USD to maintain their peg. Whatever treasury holdings they are holding now cannot be controlled but what they can do is to limit their need to buy more in the future. Having a peg will mean that they will have to keep buying USD to maintain it. All I can say is, the Americans better be careful what they wish for. They have been wanting this de-peg to happen but they do not see the risk of the chinese totally moving away from US treasuries. With the need to raise money to finance their debt, the US is heavily dependent on the Chinese to continue to support them by accumulating more US treasuries. What happens when they cannot gain financing support from the Chinese in the future?
Well that will be a discussion for the future. In the mean time, I would like to say, focus on companies that derive their earnings in RMB, Chinese companies that import foreign goods for their businesses and companies that depends heavily on domestic consumption. For specifics, I will leave it to another post.
Have a great week ahead.
Best,
SVI
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