• Expert Opinion

Patient investors, seeking to increase their principal by 20 to 30 percent in the course of the next few years, could do far worse than to invest in the Chinese currency, otherwise known as the Yuan or the renminbi.

In spite of mounting American and international pressure, from mid 2008 to mid 2010, China adamantly refused to allow the renminbi to appreciate against other currencies, particularly the US dollar. Instead, seeking to prevent its exports (which are by far the biggest contributor to the country's feverish pace of economic growth) from plummeting in the face of the creeping global recession, China pegged the value of its currency to the dollar. It then proceeded to print an inordinate amount of renminbis, which were subsequently used to purchase low-yield foreign, notably American, securities in order to keep China's exchange rate artificially low. Market forces were thereby prevented from boosting the value of the renminbi, as they should have, just as the demand for Chinese exports was increasing, and the country was becoming progressively wealthier.

Since June 2010, however, China has started to engineer a shift in its currency policy by allowing the Yuan to incrementally rise in value against the US dollar as well as other currencies. In the course of the last 3 decades, when China began its gradual turn towards market economics, eventually settling upon export led growth as the primary model for its economic development, this is only the second time that the country has permitted a rise in the value of its exchange rate. Between 2005 to 2008, partly in response to pressure from the George W. Bush Administration, China allowed the renminbi to gradually increase by 21 percent against the dollar. For most of the past thirty years, however, the Chinese leadership has correctly viewed the policy of deliberately undervaluing the renminbi as having been instrumental to its economic success by lowering the price of its exports.

As was the case between 2005-2008, a number of factors have once again coalesced to prompt China's key economic decision makers to countenance a slow rise in the value of the renminbi. Now, as then, there can be no doubt that American pressure, particularly the increasingly bellicose tone emanating from the US Congress, many of whose members have threatened to impose sanctions on China for subsidizing Chinese exporters at the expense of their American counterparts, may have exerted an influence on China's decision making process.

Much more importantly, however, the Chinese leadership has embarked upon the policy of slowly strengthening the value of the renminbi because it has reached the conclusion that such a policy is consonant with the short, medium, and long-term interests of China-as well as those of the Communist Party and the political and business elite affiliated with it. Why?

First of all, the policy of borrowing up to 10 percent of the total annual output of the Chinese economy each year in order to print additional renminbis is fast becoming unsustainable. The excessive expansion of the money supply has caused a massive rise in liquidity, resulting in a ballooning and tenacious inflation that is slowly chipping away at the standards of living of Chinese society, particularly its most vulnerable components. The spiraling inflation and excessive liquidity, meanwhile, are also fueling bubbles in China's housing and stock markets.

As expected, China's repeated attempts at dealing with the symptoms of these problems by imposing higher interest rates, tighter restrictions on bank loans, increasing the amount of money that banks are obliged to hold in reserve, and price controls have thus far only produced partial and unsatisfactory results. Officials at China's Central Bank recognize fully that in the short to medium term, the best means of combating the pernicious effects of inflation which, due to small salaries and low profit margins, is even more despised in China than other parts of the world, is allowing the renminbi to appreciate against other currencies.

Concomitantly, China's decision makers know that in the long-run, a stronger renminbi would help to boost the purchasing power of Chinese workers and consumers by making imports less expensive. It would also help to expand domestic consumption, enlarge the domestic consumer market, and thereby make the country less dependent on exports as the primary means of generating economic growth. Leaders are also cognizant of the fact that reduced dependence on low-value-added manufacturing concentrated in the country's southern coastal areas could pave the way for greater attention to the development of the less modernized parts of the country. Even more importantly, diminishing reliance on simple manufacturing can also usher in and facilitate the transition that China would eventually have to make from being a primary exporter of low-end manufactured goods to higher-end, more technologically sophisticated, products.

Nevertheless, potential would-be investors in the renminbi and exporters across the world keen to penetrate the Chinese market should not hold their breath for the Chinese government to allow the renmibi to trade at its fair market value overnight. With a pending leadership transition and a public opinion that is highly nationalistic in outlook, no Chinese leader would want to be seen as caving in to international, especially American, pressure on the nation's exchange rate. More importantly, a rapid and precipitous increase in the value of the Yuan is sure to result in bankruptcies, factory closures, and increased unemployment in the important manufacturing sector, alienate powerful economic and political constituencies, while giving rise to potential social and political turmoil.

On the other hand, slow, gradual, and incremental increases in the value of the renminbi would enable the Chinese economy to gradually adapt to changed circumstances-while benefiting from the gains discussed above.

Patient and savvy investors should be alert, recognizing that incremental growth rates, compounded over time, can add up to make a significant difference.

This article provided courtesy Dr. Dariush Zahedi who is currently Lecturing at the University of California, Berkeley