A losing battle for renminbi supremacy

Asian currency moves are deeply misunderstood. China is not winning the currency wars, it is losing them – and falling drastically backward in manufacturing competitiveness.

Asia came to currency early, and it soon learnt to treat coinage as a weapon of war. Indeed, the coins minted in China during the warring states era, almost 500 years before Christ, were made in the shape of knives.

This may explain why the west tends to be terrified by Asian currency policy. China has long been branded a currency manipulator. Japan’s aggressive new attempt to stimulate its economy with monetary policy under prime minister Shinzo Abe has led other countries to complain that the yen is deliberately being devalued.

And yet Asian currency moves are deeply misunderstood. China is not winning the currency wars; it is losing them. It has steadily lost competitiveness in recent years, and the financial press now even raises the question of whether China could soon suffer a dollar shortage, a question that would elicit gasps and laughter in the west.

Meanwhile, whatever Abenomics and the weaker yen are meant to achieve for Japan, they have so far done nothing to help Japanese exporters. The beneficiaries are quite different.

Let us start with China. The renminbi has gently appreciated by almost 10 per cent since the Chinese authorities started allowing it to rise again in June 2010.

But that understates its loss of competitiveness. Chinese inflation, however it is measured, has run far ahead of the US, so its real effective exchange rate has appreciated far more. And wages, last year, rose more than the economy as a whole. That is all part of the Communist party’s plan. Wages need to rise so that people recognise that they have some reward from the country’s great economic growth of recent years.

But it drastically diminishes the competitiveness of a strategy that has until now been based on cheap labour. Small wonder that manufacturing jobs are returning to Mexico, and even to the US itself.

For the new Chinese leadership’s plan to work, the stronger renminbi must spur exporters into improving productivity - proving that they can manage companies better, and not just exploit workers. And it must also spur capital to move into sectors that serve the Chinese domestic economy, and further the growth of a consuming middle class.

Buying such companies has already been profitable. The CSI 300 consumer discretionary index has returned 116 per cent since the Shanghai and Shenzhen markets hit rock-bottom in October 2008. That is virtually double the 67 per cent return on the index as a whole. Industrials gained only 34 per cent in that time.

In Japan, the February trade figures, albeit distorted by the dip in trade with China caused by the new year holidays, show there is more to boosting exports than a weaker yen. Total exports fell 2.9 per cent year-on-year. Exports to the US were up 5.7 per cent - but in January, with a stronger yen, they had gained 10.9 per cent. As for the EU, the currency did little to ease the effects of the stagnant economy, with exports dropping 9.6 per cent year-on-year. Meanwhile, the volume of imports remained static, though the price of imports shot up 11.9 per cent year-on-year, thanks to the 18.6 per cent weakening of the yen.

The stock market confirms that the big exporters have not, at least yet, benefited much from currency weakening. Instead, the big winners are in financial services. Securities and commodity traders lead all other companies in the Topix since the yen’s sharp devaluation commenced in mid-November, gaining 79 per cent. Real estate and banking stocks are up 37 and 33 per cent since then. Why is this?

CLSA’s own explanation sounds reasonable. Both the yen and the financial sector are driven by perceptions of risk. And Japan’s notoriously beaten down financial sector starts with further to rally. Thus it reacts more aggressively. If Abenomics works, however, it should stimulate consumer activity.

For China, the message is that investing in its stock market may well continue to be a bad idea - as it has been for most of the two decades since the Shanghai and Shenzhen stock exchanges were reopened, with the exception of the brief and extreme bubble in A-shares that burst in 2007. Competitiveness is being lost and in the short term, at least, the government has every incentive to ensure that it is not regained. For the longer term, companies that offer some play on the Chinese consumer make eminent sense.

And oddly, the same is true for Japan. It has appeal for those who can hedge against the further yen depreciation. But the winners from Abenomics, if it succeeds, will not be the traditional exporting powerhouses; they will be the companies that profit from a reinvigoration of the Japanese consumer.

Copyright The Financial Times Limited 2013.