Sunday, April 22, 2012

The Rise of China and the Emerging Markets

I'm posting a graph from Google Finance today. It graphs the relative movement of various currencies over the past few years. The graph is extremely interesting. The baseline for this graph is the USDCNY downward slope. View the other currencies against that baseline.



Some interesting observations:

  1. The US Dollar has depreciated 20% against the Chinese Renminbi since late 2005. The other way to look at this statistic is that the Chinese Renminbi has appreciated 20% against the world standard currency - the dollar. That's because its exports are in much greater demand across the world and more so in America. America has a $295 billion trade deficit with China that is fueled primarily by American consumerism and its insatiable appetite for imported goods at low rates.
  2. The US Dollar has appreciated 20% against the Indian Rupee since 2005 but we all know that the dollar isn't doing too well as a currency. What then explains this increase? The answer, my friend, lies in India's reckless profligacy. India has been running a current account deficit that it's government refuses to control (the money is being used for programs like NREGA, NHAI etc.). Foreign inflows are continually being used to finance the shortfall that the country's exchequer is facing and the situation is dire. RBI's comment on the matter? "The country's current account deficit is unsustainable." Note: As long as we're running a current account deficit, we're devaluing the currency with respect to the rest of the world because we're making interest payments in return for goods of no objective value (i.e. money in another currency). The resulting inflation in India is a testament to this devaluation. Another interesting fact to note is that the shortfall involved is 4.3% of India's GDP (NOT Tax Revenue). That figure is substantially greater than what we will be able to easily repay via tax collections since the money is being used essentially as handouts to the poor (e.g. NREGA) and not for setting up new industries or galvanizing rotting ones.
  3. Given the above two points, it's entirely not surprising that the Chinese Renminbi has appreciated 60% over the Indian rupee since 2005. Of the 60%, 40% can be accounted for by taking the US dollar as the base currency for valuation: 1 USD buys 20% less CNY and 1 USD buys 20% more INR, therefore 40% of the currency gap is accounted for. The remaining 20% gap can only be explained by the enormous bilateral trade deficit (~ $27 billion) that India runs with China.
  4. However, these 3 points don't indicate the full story. Look at the graph for CNYJPY and compare that with USDJPY. The two graphs nearly mirror each other but sometime starting in 2007 and extending through most of 2008, there was a gap introduced between the values of the two currencies. The current value of that gap is around 20%. What does that mean? Why is the USD devaluing against JPY (down 20% since 2008)? Was it the financial crisis that caused this devaluation? Alternatively, is CNY devaluing against JPY? The second explanation seems more likely. The Japanese Yen seems to be becoming a stronger currency - especially since it is a hidden part of the US-China trade deficit (Bloomberg states that South Korea, Japan and Taiwan account for a $200 billion trade deficit that China runs against these countries. This makes sense if you realize that Chinese factories are assembly lines and the components are actually sourced from these countries). 
My inference from the above indicates that the rise of China will be accompanied by the rise of these 3 countries to a much greater extent than what is currently being expected. India is a sitting loser in this series since it's not part of this virtuous cycle of products being made, packaged and exported. We're sitting on a time bomb of "service exports" to developed countries while China is sitting on a gold mine of manufacturing goods ready to be sent to countries willing to pay for them. It's hard to realize it, but we're being run into the ground by international trade and we're paying heavily for it in terms of the future of our country.


If you want to view the graph in all it's glory, have a look here. Look at it closely and draw your own conclusions. Let me know if you differ with my opinion. Have a good day in analysis!