China To Strengthen The Dollar?

From Bloomberg this morning:

As U.S. Treasury Secretary Henry Paulson visits China this week to push for faster appreciation of the yuan, the bigger issue may be what China is doing to strengthen the dollar.

Paulson's fifth trip to the nation as Treasury Secretary has taken on added urgency as the U.S. grows more dependent on the dollar's decline to lift exports and keep the economy out of recession. While the pace of the yuan's gains tripled in the past 15 months, Chinese officials now plan to increase investments in America that may boost the U.S. currency instead.

``China at this stage needs to be looking to opportunities provided by the weakening U.S. dollar,'' Ha Jiming, chief economist in Beijing at China International Capital Corp., the nation's largest investment bank, said in an interview last week. ``Very recently the government is becoming more interested in channeling money out of the country.''

The Ministry of Commerce said last week it will encourage businesses to buy American assets. Twenty insurers were granted licenses to invest overseas. China Investment Corp., the nation's $200 billion sovereign wealth fund, said it will be a ``stabilizing force'' in markets rocked by credit losses, signaling it may invest in American banks.

``We just started the going-out strategy,'' said Xia Bin, director of financial research at the State Council Development Research Center, which reports to the nation's cabinet. ``It is helpful to reduce yuan appreciation pressure in tandem with other measures, like blocking inflows of speculative money,'' he said in a Dec. 7 interview.

`Rush to Invest'

The combination of a trade surplus that reached $27 billion in October and rising foreign investment increased currency reserves ninefold this decade to $1.46 trillion, according to data compiled by the People's Bank of China.

At the same time, inflation rose to a 6.5 percent rate in October, the fastest in a decade, and regulators are concerned that the country's financial markets are a bubble waiting to burst. The benchmark CSI 300 Index of stocks in Shanghai and Shenzhen jumped 147 percent this year, pushing prices to more than 45 times per-share earnings, more than double that of Hong Kong's Hang Seng Index.

``The biggest issue in Asian markets starting from 2008 will be China's rush to invest overseas,'' said Park Hyo Jin, a strategist in Seoul at Good Morning Shinhan Securities Co. The firm is a unit of Shinhan Financial Group Co., South Korea's second-largest finance company by assets.

The yuan strengthened 11.9 percent since the end of the fixed exchange rate with the dollar in July 2005, including 8 percent since Paulson became Treasury Secretary in July 2006.

`Pace of Change'

The cost to buy yuan in 12 months with forwards fell 1.4 percent last week to 6.8075 per dollar, the biggest decline in three months. The spot rate for the currency dropped 0.04 percent to 7.4030, and declined 0.3 percent on Dec. 6, the most in one day since the peg was scrapped. It rose 0.15 percent to 7.3922 at 11:29 a.m. Shanghai time.

Paulson will try to show in the Dec. 12-13 meetings that a stronger currency will help restrain consumer prices. Chinese officials agree with the ``principle'' that they need a more flexible exchange rate, Paulson said in an interview Dec. 7. A currency that responds to market signals would help China control inflation. ``The pace of change has accelerated,'' he said. ``They need to move it more.''

``The U.S. wants a strong yuan, but what about the dollar being so weak?'' said Binay Chandgothia, who oversees $2 billion as chief investment officer at Principal Asset Management Asia in Hong Kong. ``This will form part of the posturing in the discussions.''

Strong Dollar

Paulson has been consistent in saying a strong dollar is in the nation's interest at the same time that the U.S. Dollar Index, which measures the currency's performance against six of its biggest trading partners, fell to 74.48 on Nov. 23, the lowest since it began trading in 1973. The index, down 8.7 percent for the year, rose 0.1 percent today to 76.33.

The depreciating dollar has helped American exports rise to records in the seven months through September, the longest streak since 2000, Commerce Department data show.

Exports rose to $140.1 billion in September, a bright spot in an economy suffering the worst housing slump in 16 years. The trade deficit narrowed to $56.5 billion in September from the record $67.6 billion in August 2006 as a falling dollar made American goods cheaper in foreign markets.

Record Deficit

The U.S. deficit with China, though, is set to exceed last year's record of $232.5 billion, prompting lawmakers including Senator Charles Schumer, a New York Democrat, to propose sanctions unless the yuan gains at a faster pace. U.S. growth may slow to 1.9 percent in 2008, compared with 10 percent forecast for China, the International Monetary Fund in Washington said.

The nation's leaders have growing incentives to help the dollar appreciate. China owned $396.7 billion of Treasuries as of September, up from $71.4 billion in 2000, according to the Treasury Department. Among foreign nations, only Japan, with $582.2 billion, owns more U.S. government debt.

China Investment ``wants to be a stabilizing force in the international capital markets'' just as other sovereign wealth funds have been, Chairman Lou Jiwei told a conference in Beijing on Nov. 29.

Overseas acquisitions by Chinese companies climbed to almost $28 billion this year, compared with $19 billion in all of 2006, according to data compiled by Bloomberg. The government has approved funds to raise the equivalent of $42.2 billion to invest abroad as of Sept. 30, according to central bank data. In July, the nation's insurers were allowed to invest 15 percent of an estimated $300 billion of assets in foreign currency holdings.

Initial Steps

Initial steps to invest abroad had mixed results. U.S. lawmakers in 2005 blocked an $18.5 billion bid by Hong Kong- based Cnooc Ltd., the country's biggest offshore oil producer, for El Segundo, California-based Unocal Corp. In May, China Investment, the sovereign wealth fund, bought $3 billion of shares in New York-based Blackstone Group LP. The value of the holding has fallen by $1 billion.

Blackstone is planning a bid for Rio Tinto Group, the world's third-largest mining company, that may include China Investment, the Daily Telegraph reported today. Spokespeople for China Investment, Rio and Blackstone all declined to comment.

In October, New York-based Bear Stearns Cos., the second- biggest underwriter of U.S. mortgage bonds, sold a $1 billion stake to state-owned Citic Securities Co., based in Beijing.

`Various Risks'

``Not many Chinese companies have made successful investments overseas so far,'' said Lian Ping, chief economist at Shanghai-based Bank of Communications Ltd., the nation's fifth-biggest state lender. ``We should push outbound investments further, but need to watch various risks.''

Forward contracts suggest the yuan will gain 8.7 percent over the next 12 months, compared with 5.9 percent in the past year. Some investors say they'd be surprised if the gains are that large.

``The market is expecting too much in terms of what China may do after Paulson's visit,'' said Wee-Ming Ting, who helps manage $2.4 billion of global emerging market debt as head of Asian fixed income at Pictet & Cie in Singapore and invests in yuan forwards.