2010-03-17

If the renminbi goes up, then what happens?

I believe a yuan revaluation will be inflationary. Or more accurately, a yuan revaluation will unmask the inflation that has already occurred in the money supply, but has not yet translated into higher prices.

Hong Kong dollars are pegged to U.S. dollars, and ADRs trade in U.S. dollars, so the direct impact on Chinese stocks would be negligible. However, earnings would increase in U.S. dollar terms, which would be bullish for foreign investors. Therefore, I see a gradual revaluation as very bullish for Chinese stocks because investors will have time to buy into these assets. In a financial sense, gradual revaluation is a bad idea.

If the revaluation is one-off, it will be good for stocks and cause a larger initial move, but will in the end be a smaller move. A gradual revaluation would result in a larger move because investors would not know how high the renminbi will climb and therefore would likely overestimate its gains, while at the same time creating a trend that lasts for months and draws in far more investors.

That's not to say a one-off revaluation won't generate new trends, only that they will be more complex in nature relative to a gradual climb in the renminbi, and less prone to develop into a bubble in the near future.

Also, please check out Michael Pettis' latest post on the topic. This is a great piece that covers all the major questions, and if you are an average consumer of financial news then I say with certainty that you will not find a more informed article. How will an RMB revaluation affect China, the US, and the world?

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