Jeremy Siegel on the Yuan: Buying China Some Time

Responding to international pressure as well as a desire to deal with its own macroeconomic challenges, China decided last week to revalue its currency, the yuan, or the renminbi. The People’s Bank of China, the country’s central bank, announced on July 21 that it would de-link the yuan from the dollar and peg it instead to a basket of currencies, altering an exchange rate system that has existed for a decade. China also revalued the yuan by 2.1%. What will these changes mean for Chinese companies that are trying to go global? And what will it signify for international firms doing business with China? To get answers to these questions, Knowledge at Wharton turned to Jeremy J. Siegel, a professor of finance at Wharton, and author of the book, The Future for Investors.

Knowledge at Wharton: What impact do you think the revaluation of the yuan will have on China’s economy? As you know, China has just said that it won’t revalue the yuan in the “foreseeable future.” So was this just a political move?

Siegel: It’s both political and economic. The 2.1% is obviously very small. Most experts felt that in the free market, the yuan would rise by 20% or maybe even 30%. So clearly, it’s a very tiny move. In and of itself, it doesn’t have a big impact on the Chinese economy, but what I think is important is that it signals China’s willingness to move towards a market-determined yuan rate and embrace that international system of exchange rates.

Knowledge at Wharton: China has described its new exchange rate system as a “managed floating exchange rate regime.” How will this system work?

Siegel: I wish we knew exactly how it’s going to work. There’s still a lot of mystery surrounding it. What we do know is that China will look at not just the movements of the dollar against the yuan, but also the euro and some of its other trading partners, including obviously Japan and the yen. What China is saying is that by looking at all these, it will have a basket. China hasn’t announced the proportions and maybe there aren’t even fixed proportions. Maybe it is a more flexible system, and what they are going to do on a daily basis is announce the range of trade between the dollar and the yuan. Now as long as there aren’t big movements in currencies, that will not change very much from the 2.1% devaluation. Over time however, if the dollar moves substantially downward relative to the euro and the yen, then it would obviously also move downward relative to the yuan.

Knowledge at Wharton: Were you surprised at the initial reaction of the markets to this news?

Siegel: Yes. I felt that all the hedge funds were ready for this. They all said, “Now it’s going to happen sometime, what should we trade?” There was a lot of knee-jerk reaction, [such as] selling those U.S. government bonds, because there was a feeling that maybe the Chinese will buy less of them now. It’s a step towards getting rid of them. There was a tremendous movement into the Japanese yen because of a feeling that the other Asian currencies would go up. What is interesting is that at this particular point — we are not even a week away from the move — most of this has moved back. It is now looked at from a bigger standpoint, like “Hey, maybe we overreacted in the short run.” It isn’t going to have a very important impact at least in this time frame.

Knowledge at Wharton: So are there, or are there not, a lot of speculators out there making bets on the further appreciation of the yuan?

Siegel: I think there are, and very recently the Chinese have said, don’t count on it.  Again, harkening back to my first statement, everyone recognized 2.1% is just not enough. But whether or not the Chinese government decides to, very slowly over a period of years, move it towards its right level, I feel it’s more likely that this is going to happen every two or three weeks or even every couple of months. Because if it does, then that would perhaps bring about destabilizing speculation, and I don’t think China wants that to happen.

Knowledge at Wharton: At least from the initial reaction it seemed like the People’s Bank of China was unlikely to let the yuan appreciate too fast or too much against the dollar. How much do you think the yuan needs to appreciate in order to make a meaningful difference to China’s massive trade surplus?

Siegel: I would say you need 20% to 30% — and I don’t think the Chinese want that. The Chinese are not upset about their trade surplus. It’s the Americans that are upset about China’s trade surplus. So was this a political move? Yes, certainly it was a political move, and most lawmakers in the U.S. have welcomed the move. But everyone knew it was small, and basically what they’re saying is, “Well, let’s wait a few months and see if there is any meaningful change.” Now my belief is there won’t be. So all these issues are going to return, and the pressures are going to be back on China to move faster on this issue. But this does buy the Chinese some time in the interim.

Knowledge at Wharton: So will the political pressure continue for China, both from the U.S. and from Europe?

Siegel: I think it will continue, and the forces within Europe and the U.S. will argue that the surplus is going to be good or bad for the country; or what could possibly happen is that it is not going to reduce the surplus but it might slow down the rate of growth of the surplus. Then the Chinese might be able to point out to the Americans, “Look, our exports to you were increasing at (let’s say) 20% a year; now they are only increasing at 15% or 12%.” So the surplus is still going to be there, but the rate of increase, if we continue to see some movement of appreciation in the yuan, will move down.

Knowledge at Wharton: Chinese companies such as Lenovo, CNOOC and Haier have lately made several high-profile moves to acquire U. S. companies. How will China’s new exchange rate system affect Chinese companies that are eager to acquire assets abroad?

Siegel: I think that what we saw with Lenovo, CNOOC and Haier is the tip of an iceberg. We are going to see in the next 10 to 20 years a tremendous increase in Chinese acquisition of western assets. I think India is going to participate in this. It’s my belief that given the demographics and given the flow of trade, we are going to see a very large movement of capital. I think Americans and Europeans have to set their minds at understanding these basic forces behind them.

This 2.1% move will have no deleterious affect in my opinion on the cross movements of capital. Yes, China is buying something with dollars and the dollars will be going down in value. But when people buy companies, they are looking at real values, and in the long run that moves way beyond the exchange rate. For financial assets and traders and speculators, exchange rates are very important. For long term investors, we’ve learned that it is not going to be a major force that’s going to inhibit those flows.

Knowledge at Wharton: In your book The Future for Investors, you discuss at length the role that China and India would play in acquiring assets abroad. Could you tell us a little bit about your basic argument and also what kind of assets you think the Chinese and the Indians will target?

Siegel: Yes. It’s my belief that a lot of savings and investment capital flows have to do with demographics. Baby boomers, when they were in their forties and fifties, were acquiring a lot of assets for their retirement. Once they retire, they are going to be net sellers of assets to finance their retirement. Now that’s the cycle, the young and middle-aged people acquire assets, and they sell assets when they are old to the young. Now on a worldwide basis, what we see is that China is growing older as a developed country, but they are in a very high savings period right now.

We will see in five years that the baby boomers will be moving to retirement, and they will be distributing assets. So we are going to see a flow from the baby boomers to the Chinese. I hope we see that flow because my research says if the Chinese and the Indians do not step up to the plate and buy those assets, we will see stock markets, property markets and even bond markets at much lower levels. This is going to hurt Americans and hurt their desire to use their assets to finance retirement. It’s going to mean having to work a lot longer than we now plan to work. So this acquisition of assets is very important to Americans to achieve the type of retirement goals that they have at present. That is why we in America have to look forward to those forces and understand how they fit into our economy.

Knowledge at Wharton: There is a lot of skepticism about official economic statistics coming out of China. What do you think are the real indicators of the Chinese economy? And by those yardsticks is the economy continuing to grow at an increasing rate or is growth slowing down?

Siegel: I think Chinese growth is going to continue at a very rapid rate — and that means 8% to 10% real GDP growth for several decades. I don’t see anything slowing it up at this particular juncture. Now there are always problems with measuring output in developing countries; especially in the poorer areas, a lot of transactions don’t go through the market. And that’s always one difficulty in terms of measurement. And in China, there’s a lot of inefficient allocation of capital. But you know what, that is true in every country in the world. Take a look at Japan, with all its public capital, the roads, the bridges that were built, the places that people didn’t want to go — all in an attempt to stimulate the economy. So people say there is a lot of waste, which is true of all economies. But in China what we do see is a commitment to building infrastructure and to further the manufacturing and exports. Those are tangibles that we can see. And they are growing rapidly. Again, at this particular juncture, I don’t see anything stopping the rapid growth of China.

Knowledge at Wharton: What countries do you think will pay the price for that rapid growth?

Siegel: Well, I think we can all gain from that rapid growth. There are always the environmental concerns, you know, that the Chinese don’t have unleaded gasoline laws the way that we do, and developing countries because they are poor don’t have as much emission control. We have to worry about those environmental impacts, but the economic impact is going to be favorable. We are better off if one of our trading partners is better off. They’ll have more goods of better quality to trade with us.  So that’s one of the good aspects of economics. It’s a way that we can all cooperate and benefit from other people being better off. Economics is not a zero sum game, where if the Chinese win, we lose. We can both be winners.

Knowledge at Wharton: What about the other Asian economies, especially Japan? It’s the second largest economy in the world now. Should the Japanese be worried about the impact of China’s exchange rate system change?