Carl Huttenlocher, CIO of Hong Kong-based US$2.4 billion-under-management multi-strategy hedge fund Myriad Asset Management, presented the following speech at the Sohn Conference Hong Kong on June 12, 2014
Historically, betting long the Chinese currency has provided great risk-adjusted return over the past nine years. The RMB has increased 36% in the past six years. Since January, the Chinese currency has declined around 3%.
The consensus in the market right now is that this is just a small depreciation, and the RMB will soon stabilize after the Chinese government felt that they have shaken out the currency speculators.
But going forward, we think having a weakening Chinese currency is the best option for China, if the country is going to maintain a growth rate of around 7%.
Let’s first look back on the Chinese growth in the past decade or more. From 2001 to 2008, the Chinese growth was led by exports, as well as investments supporting exports. Chinese exports took up around 23% of GDP in 2001, which peaked at 39% in 2006, then declined to 24% in 2013.
Post the global financial crisis in 2008, fiscal stimulus investment has been the primary GDP growth driver, particularly infrastructure related and residential investments.
As a result, Chinese residential property price has increased three times over the last decade. The ratio of residential investment versus GDP is at a similar level as in the U.S. before the subprime crisis. The country’s debt-to-GDP ratio is now at 230%, up from 2008’s 148%.
The trajectory of the debt growth is obviously not sustainable, and we think investment will decline.
What, then, will drive economic growth in China? The obvious answer seems to be consumption. Sure, we are bullish about certain aspects of the Chinese consumption sector, such as e-commerce and healthcare. But we also think certain sub-sectors will struggle. Automobile, mobile phones, personal computers, for example, will be difficult to continue its double-digit growth in the future.
But consumption alone will not be able to support a 7% growth rate for China. We think the other driver is currency depreciation.
There are three ways for China to adjust its economy after a rapid debt increase and investment boom. One is to allow a Lehman moment, which we think is incredibly unlikely. Two is the Japan option, which means a long period of deflation, falling property prices and slow economic growth. Essentially, the lost decade. The last option is to devalue the currency somewhat.
Most emerging markets can’t do this, but China can. An depreciating RMB will not lead to massive capital flight as many other countries may experience because of China’s solid fiscal position.
There are many other benefits for China as well. It will support property prices. Its massive debt will be devalued. Wage growth will be maintained, and the 3.5% inflation target can be achieved.
So, if this is the most appealing option at China’s hands, how do you go about doing it?
We think the answer is financial liberalization. There are already some programs in place, allowing domestic savers to invest money outside. If China continue to open up its capital account and free its financial markets, a weakening RMB will be able to be achieved. That is the best for China.
