New two-way risk dents enthusiasm for the yuan
This column has remarked before that nothing in financial markets is as risky as a safe bet.
That might sound screwy, but there are some good reasons for it.
If a particular trade is widely regarded as a sure-fire money-maker, then it is likely that everyone who wants to buy in has already done so.
And if all the potential buyers are already fully invested, that means there are no more buyers out there and no new money coming in to propel the price higher.
But with everyone long, there are plenty of potential sellers. As a result, there is only one way for the price to go: down.
This idea, of course, is the basis of contrarian investing. If everyone is in love with a stock or a market, it is probably overbought and primed for a fall. Similarly, if everyone agrees a particular asset is a dog, then it is almost certainly over-sold and ready to rally.
This dynamic can be even more powerful in the foreign exchange market. That's because exchange rates are relative prices: the price of one currency expressed in terms of another.
When everyone is convinced that a particular currency is a screaming buy, they often forget to consider the other currency in the pair.
We saw this tendency at work towards the end of last year, when everyone was so bullish on the Chinese currency's prospects, they sold Hong Kong and US dollars and loaded up on the yuan in droves.
But buying yuan was anything but a sure thing. As this column warned in early January, 'the outlook for the US dollar, to which the Hong Kong dollar is tied, is looking far more positive today than a year ago.'
With the US dollar likely to strengthen, Monitor argued, 'the appreciation of the mainland currency against the Hong Kong dollar will slow or even go into reverse.'
That's what we are seeing now. As the European crisis has flared up once again, investors are fleeing the euro-zone and seeking safety in US dollar denominated assets. There are even rumours that central banks, which over the last 10 years diversified their reserves out of US dollars and into euros, may now be reversing their move and selling down their euro holdings in favour of the greenback.
As a result, the US currency has strengthened sharply, rising 4 per cent against a broad basket of currencies over the year to date.
Anxious to preserve the competitiveness of Chinese exports, the officials who steer the yuan's exchange rate have halted its crawling appreciation against the US dollar, and even allowed the currency to weaken a little. Against the Hong Kong dollar, the yuan is now down by almost 1 per cent over the year so far.
Suddenly investors have woken up to the realisation that their sure-fire bet on the yuan actually involved some unpleasant two-way risks.
On the mainland the growth of yuan-denominated demand and savings deposits has slowed to its slowest rate in almost five years, while foreign currency deposits have soared by US$67 billion over the four months to the end of April, a year-on-year rate of increase of 53 per cent.
In Hong Kong, the use of the yuan for trade settlement was down by 25 per cent in April from its December 2011 peak. And yesterday the Hong Kong Monetary Authority announced that the pool of yuan-denominated deposits in Hong Kong fell to 552 billion yuan in April, down 12 per cent from November's high.
But although this waning of enthusiasm represents a short-term setback for Beijing's efforts to persuade the world that the yuan is an international currency, it is unlikely Chinese officials will be too bothered.
They have long wanted to scotch the impression that the yuan is a one-way appreciation bet and to introduce the perception of two-way risk to deter destabilising inflows of 'hot money' short term capital.
In the last few weeks they seem to have succeeded.
Speaking yesterday at the inaugural session of the Asia Global Dialogue - a new talkfest sponsored by William and Victor Fung's pet think tank - former mainland bank regulation boss Liu Mingkang boasted that 'Chinese tax-payers did not have to pay a penny' to bail out the country's banks following the bad loan crisis of the late 1990s.
This was disingenuousness in the extreme. What Liu neglected to mention is that on average over the last 10 years the authorities have kept benchmark savings rates below the rate of consumer inflation, handing Chinese depositors a negative real return on their savings.
That guaranteed banks artificially fat profits on the spread between their deposit and lending rates, so bailing out the banking system at the expense of ordinary savers.
If they don't get you one way, they'll get you another.