The Chinese government hinted that it may extend the trading band for its currency, the Chinese Renminbi, known also as the Chinese Yuan. Making the trading band larger would allow for the Chinese currency to rise and fall more rapidly than at present, as the central bank would be less active in managing its value on the world currency markets.
Investors should wonder what these changes might bring for the Renminbi, and also the leading trade partners with China.
Here are a few outcomes of a wider trading range:
- Yuan volatility – A wider trading range necessarily creates more volatility in Renminbi-denominated pairs.
- Wide-scale adoption – If the Renminbi is to become a reserve currency as many people predict with incredible repetition, it would have to accept a wider trading range. Whether the wider trading range is a predictor of a new global reserve currency is doubtable, at best.
- Implications for trading partners – A rising Renminbi is bad for China’s domestic producers and manufacturers, but good for consumers and international trade partners. In particular, Australia would likely benefit most from a higher Renminbi value, since its exports would have better pricing power against domestic Chinese producers.
Truth About Australia’s Economy
The Australian economy is typically seen as part of the risk trade. As it is a leading exporter to emerging markets like China, it offers more risk than other international economies and their representative currencies. Also, the high interest rate on any Aussie dollar denominated pair makes it a key part of the carry trade, which is known to create volatility due to surging speculative interest.
Finally, Australia is viewed as a proxy for commodities. That is, investors buy Australian investments when they expect higher commodity prices, as Australia is a large commodity producer. This viewpoint is often taken far beyond reality, however. Less than 10% of Australia’s output is related to commodities, specifically, mining and energy.
Growth is difficult to sustain. From first glance, Australia’s mines appear to be big business. Recent articles tell stories of previously unskilled individuals working in Australia’s mines earning $100,000 or more per year – one high school dropout makes $200,000 per year in Australia’s mines.
Australia’s economy isn’t as strong as the anecdotal evidence might otherwise suggest. Look at the most recent GDP growth:
Then subtract inflation from the above GDP growth figures:
Net of inflation, Australia’s economy appears to be in a period of no growth, and in the worst case, negative growth. Interesting, it is in periods where China’s trade balance strikes a new high that the Aussie Dollar appears to do the same.
The AUDUSD is highly correlated to China's import growth.
Bet on China?
If it were true that China would relinquish virtually all controls on the Renminbi’s value, then a play on the Australian dollar would appear to be a sure bet. A more expensive Renminbi would be good for the Australian economy, and growth would likely normalize into positive inflation-adjusted GDP growth.
But all of this is contingent on China following through on a policy it has merely hinted that it might follow. No promises have been made as to how China will involve itself in the currency markets, though one might expect that until the Chinese act, any rumors and suggestions should be taken merely as rumors and suggestions.
Forex traders, speculators, and investors know that words from China are often met with little to no action. And it is action that will ultimately determine whether or not the Australian Dollar makes a good play on a floating Renminbi.
For now, the carry trade is the only thing supporting the AUDUSD pair. At current price, we tend to think it does not warrant any investment activity, long or short.
