Chinese Bond Investment Theory

The world knows that the Chinese Yuan is undervalued. The Economist had a recent article that says that the European Union will start making noise and putting political pressure on China to pull the Yuan up to a reasonable level.

The Yuan is pegged against a basket of currencies, but is allowed to float at .3% a day. Since this “soft-peg” was put into place, the Yuan has done a straight-line appreciation against the US dollar. Using simple math, I calculated that the Yuan has an annual appreciation of about 35%, assuming 200 trading days per year and that it hits the limit every day.

This would indicate that the Yuan is a great investment for people holding dollars. However, I’m pretty sure you won’t be able to find a fool who will take the other side of that trade without a significant risk premium. Consequently, to invest in the Yuan, you need to buy hard assets in China.

The easiest investment in China would be to buy Chinese stocks, but the Chinese stock market looks overvalued and is a minefield that I want to avoid. Other assets, like real estate, seem like they would be very difficult to acquire and hold. Another option is to purchase Chinese bonds preferably longer-term government issues with reasonable interest rates. Unfortunately, the Chinese government does not have many bonds outstanding, with the exception of “Panda Bonds.” Also, it seems as if it is illegal to repatriate Yuan income from those bonds.

Alas, it seems that the only viable option would be to purchase Chinese corporate bonds. It may still be difficult to repatriate the income from those bonds. Of course, “TANSTAAFL“! There is a lot of geopolitical and country risk to this strategy.