The China Factor

China is becoming increasingly important to forex traders in evaluating trading opportunities.

This article provides a review of key China developments that every trader should know about.

Watching Chinese economic developments is likely to become a daily pastime for many traders all over the world. Since the 1970s, China’s growth rate has been approaching over 10 percent per year. In 2006, the Chinese reported that China’s gross domestic product (GDP) reached 20.94 trillion yuan, up 10.7 percent from the year before (Financial Times Information). Almost every day there is news on China’s economic performance.

China is impacting every region of the world and every industry. For example, the Chinese Ministry of Information Industry reported that China has the world’s second largest population of Internet users after the United States, with 137 million people online.

In March 2007, China replaced the United States as Europe’s second biggest source of imports after Britain. This occurred after a 21 percent increase in imports from China to the 25 countries forming the European Union (Financial Times, March 23, 2007, p. 2). China’s trade with Russia is another example. The trade between China and Russia is reported to exceed the 30 percent per year growth from 1999 to 2005 and is now over $7 billion per year (China economic net). Over half of China’s trade is within Asia, between Japan and South Korea. Regarding China and the United States, it has been reported that “from 2000 to 2005, U.S. exports to China grew almost 160 percent, while U.S. exports

to the rest of the world rose by only 16 percent. During that period, China accounted for roughly 25 percent of total U.S. export growth” (C. Fred Bergsten, Bates Gill, Nicholas R. Lardy, and Derek Mitchell, China: The Balance Sheet: What the World Needs to Know Now about the Emerging Superpower. New York: PublicAffairs, 2006).

It will certainly benefit all to become familiar with China’s economic events and how they may impact currency moves. Let’s explore some key factors.

CHINA REVALUES YUAN: A TURNING POINT? On July 21, 2005, after more than a decade of strictly pegging the renminbi to the U.S. dollar at an exchange rate of 8.28, the People’s Bank of China (PBOC) announced a revaluation of the currency and a reform of the exchange rate regime. This was the beginning of a long-term strategy to integrate China into the world economy by easing the ability of capital to flow into and out of the country. The ability to exchange currency is a key factor in this process of integration. The revaluation signaled that China was beginning to allow the strengthening of its currency. As of March 2007, the renminbi value was at approximately 7.74. This means that it takes fewer renminbi (6 percent) to convert to one dollar since revaluation. Many economic studies believe that a free-floating Chinese currency would appreciate by 20 percent. Under the foreign exchange reform, the PBOC incorporates a “reference basket” of currencies when choosing its target for the renminbi. The five currencies are the U.S. dollar, the yuan, the yen, the Korean won, and the pound. However, the exact weighting of these currencies in the basket is not being disclosed and there may be other currencies included.

Even though the Chinese currency known as the renminbi does not float on the market, and it is tied to the dollar within a narrow price, the influence of China on global currency flows is profound. This limited managed float in effect is a subsidy for China’s manufacturers and lowers the cost of Chinese goods, making competitor firms in the United States and the rest of the world very upset with China. There is increasing pressure on China to allow the renminbi to increase in value, either through a wider managed envelope or through a full float. A full float is highly unlikely because the Chinese government is not interested in giving up control of its economy, which would occur in a full float. Any increase in the value of the renminbi could result in a significant benefit to exporters in the United States and Japan. In recent years, even speculation that the Chinese were about to allow the renminbi to increase in value led to price moves that strengthened the Australian dollar and the yen.

China is becoming a global economic power that impacts the economic development of the world. It is the processing plant of the world, wherein many product components are imported and then put together. According to the Bank of New York, China’s top 10 trade partners (in dollars) are:

1.     European Union (18.5 percent)

2.     Japan (18 percent)

3.     United States (17.5 percent)

4.     The China Factor 29

5.     Hong Kong (11 percent)

6.     Association of Southeast Asian Nations (ASEAN) (11 percent)

7.     South Korea (9.5 percent)

8.     Taiwan (8.5 percent)

9.     Russia (2 percent)

10. Australia (2 percent)

11. Canada (1.5 percent)

In looking at China’s top trading partners, we can see that China trade is spread out among the world, with Europe, Japan, and the United States almost equally weighted.

But just over 40 percent of its trade is with Asia.

The importance of watching China’s economic conditions is highlighted by the following remarks of U.S. Federal Reserve chairman Bernard Bernanke at the Chinese

Academy of Social Sciences (Beijing, China, December 15, 2006):

The emergence of China as a global economic power is one of the most important developments of recent decades. For the past twenty years, the Chinese economy has achieved a growth rate averaging nearly 10 percent per year, resulting in a quintupling of output per person [see Figure 4.1]. In overall size, China’s economy today ranks as the fourth largest in the world in terms of gross domestic product (GDP) at current exchange rates, and the second largest when adjustments are made for the differences in the domestic purchasing power of national currencies.