For those of us who have lived in China over the last few years, we’ve seen the RMB appreciate against the USD at quite a substantial rate. Thinking back to when I arrived in 2004, the RMB/USD rate was 8.27. As of today, just 6 years later, CNBC reported yesterday that the Yuan has hit a 15 year high against the USD and that The People’s Bank of China fixed the yuan’s (6.7373) mid-point to the dollar at its highest level since the yuan’s landmark revaluation in July 2005. That’s a 22.75% increase in just 5 years! As far as the United States is concerned, they couldn’t be happier as the rapid increase in the RMB rate has helped to decrease the cost of goods imported to the US from China. However, for those of us working in China earning income in USD, this poses a major threat to our earning potential.
Foreigners living overseas will always be prone to currency risk especially if they are earning an income in the currency of their home country. For example, if you live in China and are getting paid in USD, your income will fluctuate on a daily basis depending on the RMB exchange rate for that day. The same goes for business owners who are located in China but receive USD revenue from overseas. Their revenue is affected by the RMB / USD rate and as the RMB appreciates against the USD their revenue or purchasing power will decline. There are many ways to hedge against the declining USD but before discussing your options it is important to understand just how serious of an issue the appreciating RMB can be to your income.
How Does The RMB / USD Rate Affect My Income?
Although living and working in China provides us with great opportunities, the declining US dollar is certainly NOT one of them. For those of you who are being paid in RMB you have nothing to worry about, but employees receiving their income in USD, unfortunately you are guaranteed to lose money each year the RMB appreciates if you haven’t already. Let’s imagine that you have lived in China for the last five years (or maybe you really have been) and that you have received an income of $100,000 per year and are being paid from an overseas employer. We’ll refer back to 2005 and assume that you started working in China that year. The RMB / USD rate was 8.27 at that time which means that your income of $100,000 would have bought you RMB827,000. Assuming that you made $100,000 per year over the next five years, by the year 2010 with the RMB / USD rate now at 6.7373, that same $100,000 salary would have decreased to RMB673,730. That’s a 22.75% decrease in your income. Each year the RMB appreciated against the USD your earning potential would have decreased. Below is an illustration outlining the impact on your salary each year.
According to the above table, even if you were given a 3% pay rise in line with inflation, you still would have suffered a loss of annual income because on average the RMB appreciated against the USD by 4.6% per year. In 2008 alone, your earning potential would have decreased by 8.3%!
How Does The RMB / USD Rate Affect My Spending Power?
So if you thought the fact that your income declining as we speak wasn’t horrifying enough, you’re probably going to be even more frustrated to know that your spending power is as well. We’ll use a simple pint of beer at the bar (or as you Europeans call it, “the pub”) to illustrate my first point. Again referring back to 2005, let’s imagine that a pint of beer costs RMB40. With the USD / RMB rate at 8.27 during this time period, that beer would cost you equivalent $4.84. Not bad for a beer considering most major cities in the world can be much more expensive. Five years later however, that same beer that cost RMB40 in 2005 now costs $5.94. And this is not even taking into consideration the affects of inflation over the same five year period that has pushed the price of consumer goods up even higher.
But if you love your beer and aren’t too fussed with the fact that your social life just got 22% more expensive, let’s take a look at how much it costs to rent an apartment where the increase in numbers are much more severe. When negotiating your rent with your landlord this year you need to take into consideration the affects the RMB appreciating against the USD will have. Let’s say you rented an apartment in January 2008 when the RMB / USD rate was 7.23 and you signed a two year lease for RMB16,000 ($2,213) per month. You’ve locked in a rental price for the next two years and feel good that regardless of what happens to the property market, there’s no way your rent will go up. Right? Wrong! Because of the currency risk in this situation you are still exposing yourself to the potential increase in rent based on the USD depreciating against the RMB. Remember, although the rent is fixed at RMB16,000 you are still receiving your income in USD. Referring to the below chart again over the course of 2008 the RMB appreciated 8.3% and in 2009 a further 7.31%. This means that your rent would have increased by 15.6% during that two year time period because the USD lost 15.6% of its value to the RMB. That same RMB16,000 is now worth $2,374 which means your rent actually increased by $183.67 per month in 2008 and by an additional $161.77 per month in 2009. Over the two year period you paid an additional $4,137 then what you negotiated with your landlord. Although the rental price of RMB (16,000) never changed, the amount you spent on your apartment because you earn in USD certainly did.
How Does The RMB / USD Rate Affect My Business?
Business owners who run a local China operation and are earning USD are most susceptible to the currency risk. Company’s are literally going out of business because they’re finding it difficult to maintain the profit margins they need to keep the doors open as the RMB gets stronger against the dollar. The import / export industry has suffered the worst over the last five years because of their exposure to the dollar so I’ll use them as an example to illustrate just how bad the appreciating Yuan can be for business.
Let’s say you own a factory locally in China that produces wine glasses. You have 200 Chinese staff and you sell your goods to customers in the United States who pay you USD for your product. Referring once more back to 2005, we’re going to assume that you opened the doors when the RMB / USD rate was 8.27 and that your total monthly outgoing costs were RMB765,400 ($92,551) (monthly rent RMB165,400 ($20,000) + staff wages RMB600,000 ($72,551)). Now let’s imagine that you sold 1,000,000 wine glasses each month for $.20 each; your revenue would be $200,000 (RMB1,654,000). Your pre-tax monthly profit would be $107,448 (RMB888,600). Not bad for one month profit! But unfortunately things are going to change very quickly for you as the USD begins to depreciate against the RMB over the next five years.
Coming back to 2010 with the RMB / USD rate now at 6.7373 let’s take a look at what happens to the profit margins of the business. Because you are paid in USD it is imperative that you convert your USD to RMB to pay local onshore expenses. This is where you are exposed to currency risk. Although your monthly RMB expenses are fixed, you are going to find that it costs you much more in USD to run your operation. Where before it only cost you $92,551 (RMB765,400 / 8.27) in 2005, it will now cost you $113,606 because the rate is now 6.7373. This means that your company’s expenses have increased by 22.75% over the past five years, and this is without giving a single pay rise to any of your staff. Sure, you can raise the price of your wine glasses to compensate for the loss, but that may be a dangerous move if you don’t remain competitive. Now let’s take a look at what happens to your income. The $200,000 that you used to be able to convert to RMB1,654,000 ($200,000 x 8.27) is now only worth RMB 1,347,460 ($200,000 x 6.7373). That’s $45,472 less each month when converted to RMB to invest back into your business! This means that your purchasing power has decreased by 22.75%. So because of the currency risk and the currency risk alone, you’re expenses have increased by 22.75% and your spending power has decreased by 22.75% therefore shrinking your profit margins dramatically in just a short period of time.
Now this doesn’t just happen in China of course as the situation would apply to any country that your conducting international business in especially when dealing with multiple currencies. The major difference however between China and most other countries is that the Yuan does not “float” like other currencies. The Chinese government very much controls the appreciation of the Chinese Yuan and due to the amount of pressure the United States is putting on China to let the Yuan appreciate, there’s only one direction the Yuan is going to go. So throughout the last few years and over the next couple we can expect the USD to decline further against the Yuan causing those earning USD in China to suffer from the currency play.
Is There Anything I Can Do To Hedge Against The Declining Dollar?
I thought you would never ask! The answer is yes, but you have to be clever about it. Snatching up all the RMB you can get your hands on is NOT the answer. Not to mention, the People’s Bank of China (PBOC) allows a maximum amount of $50,000 equivalent in RMB to be converted each year so this will only get you so far. And even if you do decide to convert USD to RMB each year you will still have serious issues converting RMB back USD when it’s time to take your money home. (see my post: Converting USD To RMB. What You Need To Know Before Converting Foreign Currency To RMB).
Another option is to speak to your employer and ask that you get paid in local RMB. This way you completely eliminate the currency risk altogether. If your employer is an overseas company you may find it hard to persuade them as the risk would then lay with them. Remember, if your salary is fixed in RMB and the company that is paying you deals in USD, then they are guaranteed to lose money throughout the course of the year. If you’re worth it of course, then go for it!
If there is absolutely no way you are able to persuade your employer to pay you in RMB or getting around the fact that your business must earn it revenue in USD, then there is another viable option in order to hedge against the declining dollar. This option has to do with investing in RMB denominated assets which are sure to appreciate with China’s rising economy. At Elite Investment Group, we deal with this situation all the time and have invested well into the millions of dollars over the past five years into stocks, bonds, funds, and other instruments that allow us and our clients to take advantage of China’s growth prospect. For example, Barings Greater China Fund, that we’ve helped many clients to invest into over the years, has shown an annualized return of 17.4% from 2005-2010. This has helped our clients to hedge against the depreciating USD if that is what their intention was. Not to mention, 17.4% per year is phenomenal considering the global recession. However, this is just one example of how you are able to invest in China’s growth, and the fund’s performance could have very well gone the other way which is why it is always smart to speak to an investment firm who can explain to you both the pros and cons when deciding whether to use investments as a means of hedging against the depreciating dollar.
For those of you who are familiar with China’s stock market, you would already know that foreigners cannot invest in the local A-share market which means they are forced to seek alternative routes to capitalizing on the growth of china companies. There are however several alternative methods of investing in China without putting your money into the A-share market. The Hang Seng in Hong Kong, Shenzhen B market in Shenzhen and overseas ADR’s (NYSE) are all ways that investors can purchase Chinese stocks on various stock exchanges’s. (see my post: Investing In China Without Investing In China to learn more about your options.