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China's Bang for the Buck


The falling dollar could be bad news for many countries that count on the U.S. as a prime export market. A depreciating dollar will make imports more expensive, while U.S. exports to the rest of the world become comparatively cheaper.

Surprisingly, however, the decline in the dollar could greatly benefit China, says Stephen L. Jen, chief currency economist at Morgan Stanley. Since early 1998, China has unofficially pegged its currency, the yuan, to the dollar at an exchange rate of about 8.28 to 1. That means as the dollar has deteriorated against the yen, euro, and other currencies this year, the yuan has declined as well.

The implication: If Beijing continues to tie the yuan to the dollar, a depreciating dollar won't slow U.S. imports from China, says Jen. Nor is it likely to narrow America's trade deficit with China, the largest for the U.S. among its trade partners in 2001.

And riding the depreciation of the dollar, China's exports to the rest of the world will become more competitive as well. After the U.S., China's biggest destinations for its goods and services include Japan, South Korea, and the euro zone. Already, both the Japanese yen and Korean won have climbed better than 8% against the dollar this year, while the euro has gained 10%. The stronger currencies will only add to China's already growing global trade surplus (chart).

Jen forecasts a 20% depreciation in the dollar by the end of 2003. If that is matched by a similar decline in the yuan, China's improving trade balance might not be the country's only bright spot. More foreign corporations may take advantage of the weakening yuan and already inexpensive cost of labor, sending even more business China's way. When bears overrun the stock market, investors traditionally seek safety in bonds. But this time around bonds may not offer the safe haven investors are looking for, says a study by Tobias M. Levkovich, a senior institutional equity strategist at Salomon Smith Barney.

A big fear of equity-shy investors is that all the air still hasn't been squeezed out of the stock market bubble. They note that the Standard & Poor's 500-stock index is trading at 20 times projected 2002 earnings, well above the average multiple of 15.7 that the index has maintained over the past 42 years. That's a 22% premium to the historical average.

Unfortunately for investors, bonds are also trading at a premium, Levkovich notes. Since 1960, the average yield on the 10-year Treasury note has been 7.25%. That makes the current yield of around 4.75% more than one-third below this average.

In part that's because of low inflation. But bond yields respond to more than just inflation, so interest rates could rise even as inflation stays quiet, causing bond prices to plummet. "Investors think they're safe in bonds, but this bond market is not risk-free," says Levkovich. Fears of terrorism, a weakening dollar, and surging U.S. government budget deficits affect bonds at least as much as stocks. Moreover, every day skittish institutional investors are moving large amounts of money back and forth between stocks and bonds. As a result, bond prices have been swinging widely.

This riskiness of bonds, combined with the fears in the equity market, may help explain why money is flowing out of the financial markets and into housing. When both equities and fixed-income investments seem uncertain, the solidity of real estate becomes more and more attractive. It's often suggested that baseball teams in richer cities have an unfair edge. Franchises such as the New York Yankees, bolstered by strong revenues, can afford to pay for better training facilities and the best players, the argument goes.

Something similar could be happening in soccer, where richer countries may have a growing advantage. A study by Goldman, Sachs & Co.'s London-based economists notes that in terms of soccer wins, "the more successful nations in Europe and Latin America [are] also the most prosperous." The Goldman report also showed some correlation between per capita income and the rankings of FIFA, the international soccer federation.

Richer countries did seem to make a better showing in this year's World Cup, at least in the earlier rounds. The 32 nations in the 2002 tournament included 9 of the biggest 10 economies. Among them were the U.S. and Japan, the world's two largest economies, which only recently have begun to field top-quality teams. By comparison, the group of 32 in the 1998 World Cup included only 7 of the biggest 10 economies.

It's difficult for poor countries to pay for the best coaches and team training. Out of the countries that made it into the round of 16 this year, only Brazil, Paraguay, Senegal, and Turkey had a per-capita income below the global average of $6,693.

But national wealth, while important, didn't have the final say in how countries fared in this year's contest. The average per capita income of the countries in the round of 16 was $16,642 (chart). The eight winners in the quarter finals had an average income of $15,238. By the time the tournament was down to four, the coun-tries' average was $12,011. Nevertheless, if rich nations keep improving, it may become harder for poor countries to compete in the World Cup on equal terms.


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