By John Richardson
THE truth is that nobody has ever entirely understood the nature of China’s chemicals and polymers demand.
During the good times, at the height of China’s credit Ponzi scheme, if you were a sales manager, why ask too many questions? Sales were sales and if mono-ethylene glycol (MEG) ended up stuck in tanks for months, or plastic pellets were left in a warehouse somewhere in China’s hinterland for even longer, who really cared? All that mattered was that you counted your bonus at the end of the month, quarter or year.
Equally, nobody at any level in some chemicals companies asked too many hard enough questions about whether China’s entire economic growth model was viable over the long term. “As long as sales figures are good, and our investors are happy, why worry?” seemed to be the motto.
But China’s decision to allow the Yuan to weaken against the US dollar further illustrates how we could well be at a critical turning point. Since last week:
- China’s central bank, the People’s Bank of China (PBOC), has been intervening heavily in currency markets to drive down the value of the Yuan, analysts told the New York Times. This has led to a slide in the Yuan in order punish speculators and prevent huge capital flows, or hot money, from entering the country, the analysts added.
- By weakening the value of the Yuan, authorities hope to make it harder for speculators. This has also been an arbitrage game between interest rates in the advanced economies and higher rates in the more tightly controlled Chinese system. For speculators, currency appreciation has been a further benefit – a “one-way bet” because of the currency’s virtually uninterrupted appreciation since 2005.
- The move has come just before the start of this week’s important National People’s Congress meeting, where we could see announcements of further economic reforms. These reforms could include widening the Yuan’s daily trading band, increasing the amount by which the currency’s value can fluctuate in either direction. This would act as a further disincentive to speculators.
- Inflows of hot money have also helped to over-inflate the real-estate sector, and have complicated the PBOC’s efforts to control the overall growth in credit.
- Investors have used trade-finance deals in order to bypass tight Chinese government controls over the flows of foreign money into the country. Here is how it works: You open a letter of credit with an overseas bank in order to import a chemicals or polymers cargo. You might not actually want that chemicals and polymers cargo for its underlying value. Instead, you may want the LC that the cargo has justified in order to speculate on another commodity, such a real estate, play the interest-rate arbitrage game and gain from Yuan appreciation – or any combination of the above.
- The persistent rise in the value of the Yuan over the last year led to the inward flow of $150 billion in 2013, says UBS. That is out of $244 billion of total capital inflows last year, according to the country’s foreign-exchange regulator.
- Companies struggling with oversupply in manufacturing sectors such as steel and some chemicals have also used what some people claim have been completely fictitious trade financing in order to speculate on interest rates and the Yuan etc – in other words, chemicals cargoes that haven’t even existed.
- They also have been “over-invoicing” to get more money on-shore, which could have been the main reason for January’s surprisingly strong growth in exports.
- “Companies have used trading on the appreciation of the Yuan, in its various forms, to paper over gaping holes in their balance sheets,” said one commentator.
But there could be another motive behind the deliberate weakening of the Yuan: Boosting the competitiveness of exports.
The end-result might be that China ends up exporting deflation. Premier Li Keqiang said last October that maintaining employment was his key priority. China’s producer price index has seen negative for 22 months. Add any further Yuan depreciation to the mix and you might see substantial volume gains by Chinese companies in export markets. Volumes rather than profit could well be the focus for China as it tries to keep jobs. China will do what suits China.
Before you complain about this, the US is doing what suits the US as Fed chairman Janet Yellen made clear last month, when she said that emerging market problems would not influence QE tapering.
A lot of the collateral damage from tapering has, of course, been the result of ultra-low interest rates in the US that have encouraged the type of financial engineering that we just discussed.
And so the US might find it difficult to avoid accusations of hypocrisy if it starts complaining about a further weakening of the Yuan.