As I said yesterday, it’s just a matter of time before China’s currency starts depreciating. This will be bad news for some parts of the economy. And it could be a big boost to other parts of the economy. But what matters to the currency might matter less to investors than another big factor.
When a currency falls, or depreciates, the country’s exports automatically become cheaper to foreign buyers. After a currency falls, it takes less foreign currency to buy the same amount of local currency. The flip side is that imports get more expensive (since it now takes more local currency to buy the same amount of foreign currency). So people start spending more on things made locally, as imported goods are now more expensive.
Since the yuan began falling in June 2015, exports from China are up 4.7 percent, through December. With a cheaper yuan, it is now cheaper for people in other countries to buy goods made in China. That increase in exports might have happened anyway, of course. But it was helped by a weaker renminbi.
Meanwhile, imports – which are more expensive with a depreciated local currency – were also up over the same period, by nearly 13 percent. Given that imports had become more expensive, you might have thought that spending on imports would have fallen – not risen. So it’s difficult to say what caused what. Some analysts think that one of the main reasons China allowed the currency to drop so much was to boost exports (although imports rising as well probably wouldn’t be part of the plan).
And as we’ve said, the yuan’s recent fall is probably smaller than you think. Since the beginning of the year, the yuan is only down 0.4 percent against the U.S. dollar. Since August 1 – before the market began to focus on China’s currency – it’s fallen only 5 percent against the dollar. This is not the first time the yuan has fallen against the U.S. dollar – and it’s not even one of the worst declines.
The falling yuan is not, by itself, a good reason to start investing in sectors that depend on exporting, like China’s manufacturing sector. Those sectors of the economy could do well when China’s currency falls more, as Chinese goods will be more competitive globally.
But the key to making money in China (and anywhere, really) is to follow the money. In this case, that’s where the Chinese government is investing, and the sectors they’re supporting. The Chinese economy is, after all, still centrally planned.
The government used to invest a lot in manufacturing. Making stuff to sell to the rest of the world was the easiest way to grow the economy and to get people working.
But the Chinese government no longer wants the country to be viewed as a global sweatshop for low-end goods. As the economy has developed, and the cost of production has risen, China can no longer make stuff as cheaply. Other countries – from Bangladesh to Nigeria to Cambodia – now make more cheap stuff for the rest of the world.
The Chinese government’s latest economic plan highlights this shift, by focusing on services and consumer-led sectors as the big drivers of the economy. They want to focus more on technological innovation, high-tech manufacturing, e-commerce and alternative energy.
The government, in its latest Five Year Plan, says it wants the economy to grow through more domestic consumption. That is, they want Chinese spending money in China to help grow the economy, instead of depending on making and exporting cheap stuff.
As part of this plan, the government intends to spend more to support the development of service industries, including healthcare, tourism, sports, and education and training services.
Also, China’s pollution problem is a major focus. The government has set aside US$1.5 trillion to be spent on cleaning up the environment between 2016 and 2020. This is twice as much as it’s been spending in recent years.
China’s traditional export industries might benefit from devaluation of the country’s currency, which will be the main focus of investors for a while. But those parts of the economy will probably benefit less than the service sector, and other parts of the economy that the government is investing in. So when everything begins to get a bit more clear with China’s economy, that’s where the best investment opportunities will be.