Put that cork back in the champagne bottle. As the dust has settled, it’s increasingly clear that China’s bold actions this weekend regarding its currency may be less bold than it seems. Clearly, the Chinese yuan will get stronger and the U.S. dollar will get weaker, but it will take several years -- or longer -- for any real positive benefits to be felt. Nevertheless, you can identify the long-term winners and losers from a stronger Chinese currency.
Watching Paint Dry
The Chinese government announced over the weekend that it would loosen the fixed rate at which dollars and the yuan can be exchanged, responding to increasing pressure from lawmakers in the United States and elsewhere. That led to a quick +0.4% gain in Monday trading for the yuan. And that’s all you should expect for the near-term. From time to time, the Chinese government will slightly loosen the band further, and the currency will make another quick +0.4% to +0.5% move. But we may not see more than a handful of those moves each year. Translation: it may be several years before the yuan gains +10% from current levels, even though the currency needs to rise +20% to +30% from current levels to really have major global impact.
Instead, the impact will be moderate, and will build over time. With every move that China’s central bank makes to let the yuan rise, Chinese firms will pay a bit more for imported raw materials such as oil. And Chinese-made goods will become a little more expensive. From 2005 to 2008, China let its currency strengthen by +20%, though that rise was still not high enough to meaningfully impact the stubborn U.S.-China trade imbalances.
China is moving so slowly because it is not completely sure if the move to a stronger currency is a clear winner for the country. As it becomes more expensive to do business in China (in dollar terms), factories may close and re-open elsewhere in lower-cost countries such as Vietnam. As it stands, Chinese workers are pushing hard for raises. The number of work stoppages roughly doubled last year to around 700,000, according to Reuters. Strikes at several factories have made global headlines, and the Chinese government is looking for ways to ameliorate Chinese labor concerns, perhaps by more strictly enforcing overtime rules or raising the minimum wage. The more concessions that are made on this front, the less likely it is that China will let its currency get much stronger.
Building a Consumer Class
China knows that it cannot run massive trade surpluses forever, and would love to see the emergence of a free-spending middle class. By boosting domestic consumption, Chinese factories can stay busy, even if exports start to shrink. Of course, China’s trading partners would love to see that as well. Boosting exports to China, the world’s most populous country, would provide a clear lift to many U.S. and European firms.
Aiding imports and reducing exports could also ensure that China’s economy doesn’t overheat. Investors are cheered by the fact that China is now less likely to sharply boost interest rates to stave off any inflationary pressures. Conversely, a stronger yuan would add a bit of pressure to our inflation picture, as import costs rise.
Action to Take --> China is going to move very slowly. Share price moves on Monday appear to have captured much of the near-term gains associated with any currency efforts. For example, aluminum and steel makers have seen their shares rise +5% to +10% in Monday trading, even though their full-year results are unlikely to see any real impact. Investors instead like the fact that playing field will be leveled over the coming years.
Chinese airline stocks look like a solid play on a rising yuan. For example, China Eastern Airlines (NYSE: CEA) is up +6% on Monday on the assumption that dollar-denominated fuel costs will eventually fall, and Chinese domestic air travel will eventually rise, as the economic focus shifts more toward domestic consumption.
Firms that cater to a growing Chinese consumer class will also benefit. Video games makers such as Perfect World (Nasdaq: PWRD) are up sharply on Monday on hopes that demand will rise. It also helps that their earnings, when translated back into dollars, will get a boost.
But many U.S. and European firms stand to lose. Many high-tech companies such as Apple (Nasdaq: AAPL) and Motorola (NYSE: MOT) do the bulk of their manufacturing in China, and could be hurt by a double whammy of rising labor discontent and a stronger yuan. Over time, a number of multinationals may look to shift their manufacturing bases to other parts of Asia, or even move some production back home.
Purveyors of high-end goods may also benefit if a rising currency and a rising upper-income class lead to more vigorous spending on fancy watches, handbags and cars. That’s precisely what happened in Japan in the 1980s, and firms such as Coach (NYSE: COH), Ralph Lauren (NYSE: RL) and others became must-own brands in Japan.
Perhaps the clearest beneficiary of a stronger yuan would be the American heartland, where so many factories have closed as production moved offshore. If the rust belt can get up off the mat, domestic spending in the Midwest may get a solid boost. As noted, the benefits will be very slow to come, but may eventually have a real impact.