China's lucky Wall Street reacted mildly to yuan move

The Insider

Your Money

July 31, 2005|By BILL BARNHART

SOMETIMES, market-moving news fails to move markets.

China's decision to unlink its currency from the U.S. dollar barely fazed Wall Street, even though global news wire Reuters called it "the biggest financial story of the year."

The news broke July 21, a day that saw a second terrorist attack on London's transit system and congressional testimony by Federal Reserve Board Chairman Alan Greenspan.

A flurry of expert advice on how to "play" the China currency story ensued: Bet against the dollar and Treasury securities; sell Wal-Mart Stores Inc. and other retailers that import from China; buy commodity futures.

But the actual revaluation was small, and none of these tips panned out in the days after the news. Having witnessed Asian currency crises in 1997 and 1998, as well as the Sept. 11 terrorist shock and the Nasdaq market bust, financial markets took the latest China story in stride.

"This was something that has long been discussed and speculated on," said Lisa Chen, an international portfolio manager for Barclays Global Fund Advisors.

"What we did know is that the timing was going to be a surprise, so in that regard it wasn't a surprise," Chen said.

It may take 10 years of economic change in China before you can look back to July 21 as a milestone date, said Mark Headley, co-manager of the Matthews China Fund.

But if you needed validation for your decision to diversify your portfolio globally, the China news was a big deal that deserves careful monitoring.

Here's what to watch for now:

China was lucky or smart in the low-key reception to its currency shift.

Its currency revaluation was minor. But currencies floated higher in less-regulated Asian countries, attracting capital after the China news.

Barclays' exchange-traded funds, called iShares, saw heavy cash flow into its Malaysian fund but little into its China fund, Chen said. In effect, Malaysia, which ended its peg to the dollar shortly after China, absorbed the speculative reaction to China's decision.

China's economy must avoid another round of hot money flooding in, Headley said.

"Then you get the bust following the boom," he said.

China's textile exporters, which were major beneficiaries of the dollar/yuan peg, will suffer, pushing plants and employment to other Asian countries.

"Some of them shouldn't be in business, anyway," said Edmund Harriss, portfolio manager for the Guinness Atkinson China & Hong Kong Fund.

But Chinese companies manufacturing for domestic consumption should benefit.

China wants to shift from cheap exports to domestic production and higher value-added exports, Harriss said.

China needs to make non-currency reforms, mostly in its banking system.

Moreover, the government should stop subsidizing energy costs, said William Fries, managing director of Thornburg Investment Management.

China also must stop piracy of intellectual property, from computer software to entertainment DVDs, Headley said.

"China is a country with enough power. Why aren't they doing this?" he said.

If steady progress continues in China, emerging markets will become mainstream investments.

Bill Barnhart is a columnist for the Chicago Tribune.

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