New Debutante at the Ball: Does Yuan Revaluation Mark Formal Coming-Out of Asian Consumer?
Many analysts evaluating the Chinese Yuan revaluation are focusing on the fact a 2.1% band is unlikely to raise the relative competitiveness of U.S. manufactured goods. Others question its impact on U.S. consumer spending. The subsequent "solemn declaration" by the People's Bank of China (PBC) that this change "does not mean this adjustment ... is a first step ..." has only reinforced the prevailing skepticism.
This view misses the point. Irrespective of any announcements by the PBC - who are obliged to cool down speculative sentiment to prevent large inflows of hot capital -- it should be clear this marks a major step in a long-term adjustment process. Former U.S. Undersecretary of the Treasury for International Affairs John Taylor characterized it in a recent Bloomberg radio interview as being similar in importance to the U.S. abandoning the Bretton Woods system when gold backing was removed from the dollar in 1971.
Even if one is relatively bullish on the U.S., it is hard to dispute it is a relatively mature and over-serviced economy. Consumers are highly indebted -- and most of the easy gains from corporate rationalization have been realized. There is far more growth in economies that are just beginning to realize their potential. For example, it has been estimated only 5% of the Chinese population has flown on a plane and there are less than 200 airports in China compared to 10,000+ in the U.S. Which market has the greater potential for increases in aviation services moving forward?
In India, consumer finance leader ICICI bank issued about 100,000 new credit card customers every month during 2004. Total card usage in the country doubled from 4.3 to 9 million over the previous four years. One might wonder if this is sustainable - until one realizes India has a total population of 1.1 billion. Only 53 million - less than 5% -- are estimated to be mobile phone subscribers. Indonesia's mobile telephone market is also growing rapidly - at a 70%+ compounded annual growth rate over the last six years - yet still has one of the lowest penetration rates in the region. Similar and perhaps even more extreme statistics can be found for automobiles, appliances, mortgages, luxury goods and most other consumption measures. Even more mature markets such as Japan and Korea have been showing signs of more robust consumption in recent months.
The simple fact is the U.S. cannot indefinitely sustain dramatically higher wage scales and cost structures than developing countries without further enhancing its competitive advantage. That will not be easy. One recent McKinsey Global Institute report goes so far as to predict in some industries a quarter to half of all jobs are likely to move offshore from mature economies. Neither can the U.S. maintain its role as the primary engine of world growth through a debt-financed consumer binge and dramatic inflation of housing values. The necessary correction may not be imminent and indeed many extremely bright investment managers have underperformed in recent years as they try to pick the top. Nevertheless, Paul Volcker, Julian Robertson, Warren Buffet and Peter Peterson are just a few of the many wise people who have gone on record as fearing the potentially severe consequences that may accompany the adjustment that needs to unfold.
Increased consumption in Asia - both consumer and industrial - is vital to the global economy. This trend, however, is in its infancy and in no way can Asia at present - be deemed a substitute for demand in the U.S. and Western Europe. Nor is it independent of strong correlation with movements on Wall Street. Yet the removal of the Yuan-Dollar peg is one less obstacle in the structural movement now headed in that direction.
This need not, however, be something to fear. Major business and investment opportunities are arising as Asia develops. In comparison, growth in the U.S. and Western Europe will be relatively stagnant. Given the leadership role U.S. firms continue to demonstrate in the development of intellectual property and technological applications, as well as products, content, branding, distribution and financial management -- there is no reason they cannot command a sizable share to bolster top line growth and profitability. This is true irrespective of whether they control and undertake the actual manufacturing. (For an insightful analysis on the relationship between intellectual property, branding/distribution and manufacturing and the profit margins that result, please see C.H. Kwan's "China Grows but Wealth Remains Elusive" in the Sept. 2002 KWR International Advisor.
It is also important to recognize both the role that Asian Central Banks have played in financing U.S. consumption as well as the ramifications that efforts to lift Asian demand will bring on their appetite for U.S. Treasury holdings. Nobel prize winner Joseph Stiglitz highlighted what he termed the "myth of mutual dependence" which underlies this relationship in a recent Financial Times column asking "If its government is to lend money, why not finance its own development? Why not fund increased consumption at home, rather than that of the richest country in the world?" While a move away from U.S. treasury securities is not imminent, that does not mean this will always be so.
The Yuan revaluation makes imports less expensive - not only in China - but in other Asian economies now more able to let their own currencies appreciate as well. For the moment the change is small. However, even if China's primary motivation was to alleviate political heat and no further steps are envisioned, the genie is out of the bottle. Market forces and diplomatic pressure are likely to force additional movement. Just as every quarter point rise by the Fed is largely insignificant by itself, each builds in impact over time.
Forward-looking investors can use this growth to diversify and energize portfolio returns - supplementing their U.S. and European businesses and holdings. Simon Property Group, for example, one of the largest U.S. real estate and shopping mall developers, announced last month a partnership to develop about one dozen shopping centers in China. Wal-Mart - which will have as many as 60 outlets on the mainland by yearend - will place an anchor in each center. Some will include cinemas operated by a unit of Time Warner.
Financial investors - retail as well as institutional - who recognize these developments are beginning to benefit as well. Interestingly, their focus is not on exporters, who have been the most widely owned Asian equities by foreign investors in the past -- but on those that have a domestic focus. In addition to commodity plays such as BHP Billiton (BHP) or Rio Tinto (RTP), and numerous ETF's and mutual funds, examples of U.S. listings include ICICI Bank (IBN) and VSNL Telecom (VSL) in India, iShares FTSE/Xinhua China 25 Index (FXI), Petrochina (PTR) and China Telecom (CHA) in China, Telekom Indonesia (TLK), Kookmin Bank (KB), Hanaro Telecom (HANA) and Korea Electric Power (KEP) in Korea and NTT DoCoMo (NTT), Orix (IX), Mitsubishi Tokyo Financial Group (MTF) and Nissin (NIS) in Japan. Those willing to look at bulletin board listings have even more options. A few interesting candidates include Bumrungrad Hospital (BUHPF), Noble Group (NOBGF) and Jollibee Foods (JBFCF).
It is entirely possible -- or even probable -- that along the way China and other Asian economies will falter in their efforts to manage this transition. This will lead to increased volatility, possibly the much-feared "hard landing" in China, and numerous other economic, financial, social and political pressures that exert themselves in ugly fashion. Similarly, the potential for financial crises in the U.S. should not be underestimated.
The bottom line, however, is irrespective of the potential for traumatic volatility along the way, over time Asia and other emerging economies - as well as restructuring stories such as Japan - will rise in importance when measured in terms of total demand and market capitalization in comparison with the U.S. and Western Europe. The Yuan revaluation marks a perhaps small - but significant -- step in this evolution.
As Asia increasingly exerts itself as an independent consumer and industrial market, both portfolio and direct investors need to incorporate this development into their thinking. This will include close monitoring and planning, as well as financial positions and business ventures that can take advantage of the opportunities now beginning to unfold.