Through the real estate bubble in the United States, as well as the resulting global financial crisis, China remains the go-to country for a perfect carry trade. While the carry trade is traditionally an operation of the foreign exchange market, China’s economic fundamentals, coupled with central bank activity, make it a prime investment for investors living in developed economies.
Currency manipulation is a word perhaps now better attached to Ben Bernanke than it is the People’s Bank of China. Since John Snow, Treasury Secretary under George W. Bush, first charged the Chinese as being currency manipulators, the People’s Bank of China has fought long and hard to allow their currency, the Renminbi, to appreciate.
China is now working to strengthen the value of the Renminbi by tightening monetary policy through the People’s Bank, while Bernanke, intent on lowering the value of the US Dollar against emerging nations, is injecting fresh cash directly into the reserve level at the banking system.
More simply, reserves in China are increasing as cash is sucked out of the economy, while reserves in the United States are rising as a result of direct cash infusions into the economy. China has routinely made the charge that “hot money” borrowed in the United States is pouring into local markets and investments, and frankly, there is little doubt they are correct.
The Trade of A Lifetime
There should be no question as to why China is so attractive to foreign investment. Consider first that the United States’ monetary policy is currently providing for negative real interest rates, where the rate of inflation is greater than the cost to borrow. This is the reason why commodities are on a tear; simply storing borrowed cash in a safe place provides a very consistent increase in real purchasing power.
While a play on the Renminbi isn’t as attractive as it once was (the Renminbi now trades 6.75 to the dollar from 8.25 to the dollar), it is absolutely more attractive than commodities, especially when investors glance into the final element of Chinese investment dominance: its unparalleled growth.
Going into the end of 2010, China is expected to grow some 8.5% next year, while inflation at the production level (the prices that most affect local consumers) grows by only 3.5%. Those numbers set the stage for a nation that will soon become one of the largest consumer markets in the world, rivaling the European Union and the United States.
Emerging market investors with current open positions in China have seen impressive gains from export-driven growth, but no one has yet to see the power of an internal consumption machine. Estimates suggest that in the coming years, the Chinese savings rate will drop as social security payments increase, and the population ages and eases into retirement. However, for China, that isn’t a problem. Its status as one of the leading exporters suggests that it has not only a comparative advantage in production, but that it maintains a comparative advantage, even with the ever increasing costs of international transport.
When all these years of savings are spent, mostly internally, foreign investors should be there to pick up the profits. It won’t be much longer until China capitalizes on years of hard work, savings, and a move to pure, raw capitalism. Those who embrace capitalism in the Chinese financial markets will reap the rewards of earnings growth, multiple expansion, and general capital appreciation against the miniscule opportunity costs of cheap credit borrowed and slow growth in the developed world.