What do we want? 20%! This isn’t a demand for a wage increase – or for a cut in public spending. It’s for something altogether different and potentially even more disruptive. To find out what this is, read on.
No, this isn’t a story about workers’ pay claims in China or some other fast-growing developing nation – even though similar such headlines have indeed been in the press of late, given the rising demands for more of the benefits of these economies’ phenomenal growth performance to filter through to workers’ pay packets.
And, no, it isn’t a story about how much the UK chancellor or some other developed-country government finance minister needs to cut its spending – even though similar such headlines have indeed been in the press of late, given the increasingly pressing demands to curb massive budget deficits and fast-rising public debt.
What is it about then? The answer: this is how much US Treasury Secretary Tim Geithner appears to want the renminbi to appreciate against the dollar in order to restore the Chinese currency to some semblance of fair value – as it would replicate the sort of move that took place the last time that the Chinese authorities let the currency float, rather than hold it down by keeping it collared within a narrow band – as they have been doing of late, even after the June 19 move to shift to a so-called “dirty float”.*
The call from Mr Geithner did not actually make the headlines as it was tucked away in the 25th paragraph of his Testimony to the Senate’s Banking, Housing and Urban Affairs and House Ways and Means Committee.** Nevertheless, it does mark an important shift in US tactics, if not in strategy. For no longer is the US government hinting that the IMF reckon that the renminbi is perhaps undervalued. Rather, it is quoting a “big” (and “target”) number in order to both give the Chinese something to aim for and to encourage Congress to come up with proposals that match – or even exceed – the pain level that such an appreciation would engender for Chinese exporters. (The idea seems to be threaten tariff rises that would raise export prices even more than a 20% currency move, and perhaps the Chinese will at least let the renminbi appreciate a fair chunk of the “target” that Mr Geithner is setting them.)
Interestingly, Mr Geithner is also keeping the pressure on the Chinese to make the sort of structural reforms that the IMF have been recommending to help lower Chinese households’ (private) saving rate – and thus boost the growth rate of private consumption their. (The sorts of things he has in mind are some system of state protection for some of the costs involved with ill-health, old age and job loss: At the moment, households save about half of their incomes in order to self-insure against these things.) Likewise, he adopted a pretty hawkish line on abuses of WTO rules – threatening that “we are aggressively using the full set of trade remedies available” [to pursue US interests]. Again the message is clear: we need exports – and we don’t care if you help us by making our exports relatively cheaper or by demanding more of them. In other words, the means are of second-order importance compared with the ends.
What is the bottom line of all of this?
First, that we now have a time-table of sorts that the Americans are setting the Chinese. For, by the time that G20 meets in Seoul in November, the treasury secretary is expecting China to have demonstrated their commitment to rebalancing. (This Mr Geithner suggests will “be a key part of the agenda” for that meeting.) Otherwise, he is in effect threatening, do not expect us to sit idly by.
Second, that the pressure is building for something quite big to happen. We can think of there being two main scenarios from here. In the first of these, the Chinese bow to pressure – and the rate of appreciation of the renminbi rises. (Instead of 1% per quarter, perhaps 1% per month would look a sensible offering?) And perhaps too, in such a scenario, China offers some starters on structural reforms to put in front of G20, even if they would likely be small steps on a long road. This sort of sceanrio would be great for those investors who are long Asian currencies – recognising that, as a group, they are still cheap and thus able to sustain a marked appreciation.
The other main scenario is that the Chinese ignore the threat or offer too little for Mr Geithner to call off the guard dogs – and thus a scenario in which fears of a trade war start to escalate, as say Congress is given a longer leash – and greater support – in its proposals to “bash” China. That might well mean a stronger dollar in the short term, as investors look for currencies that in the past have tended to act as safe havens. But the more important hit would be to expectations of global growth – especially as the unease would come at a time when global trade is already beginning to slow (as we highlighted in a recent blog entry).*** In other words, in this sort of scenario, it might well be that the best trade to be in is being overweight high quality government bonds, such as Swiss or German ones – again something that we have been recommending people do, and continue to do so.
For the moment, we do not have a strong call on the probability of one scenario being a lot higher than for the other. (But we suspect the probability of an alternative, third “muddle along” scenario, in which nothing much happens, is low.) So, thinking of the world as being bi-modal at the moment seems to us the sensible frame of mind when thinking about how to invest, as we have been highlighting in recent editions of our flagship products, Compass and Signpost. But, also important in such circumstances is watching to see if the probability of the two main scenarios alters, as quite a small nudge up in one versus the other might require, and hopefully elicit, a substantive shift in tactical asset allocation. So, we will be keeping a close eye on this issue in the run-up to Seoul.
* For more on that, see our blog entry made at the time…
** Mind you, with a committee name that long, it is surprising that anyone even makes it to the main text. For those who nevertheless want to, see… http://www.treasury.gov/press/releases/tg858.htm
*** For more on the deceleration in trade, see…