In free and open markets, the Efficient Market Hypothesis (EMH) is a function of the information available to profit seeking investors. However there is one scenario where the Efficient Market Hypothesis breaks down, that of collusion. While most most markets are inherently efficient there are a few notable exceptions to the rule.
The most common example of market collusion is government intervention in the foreign exchange markets. Currently many Asian currencies are pegged or manipulated by their respective governments. Governments may execute such interventions in order to stimulate exports or in other cases to make imports cheaper. The fact that Governments aren’t profit seeking institutions distorts the Efficient Market Hypothesis. In Hong Kong, Saudi Arabia and in Dubai for example, their currencies are perfectly pegged the US Dollar. However, due to US government pressures, China is following a strategy of slowly revaluing the Yuan at higher values against the US dollar.
This creates an interesting situation for profit seeking investors. Investors can invest their US dollars into Chinese Yuan and make virtually guaranteed profits, assuming the current exchange rate policy continues, which currently runs at 7% appreciation per year. So how can an investor exploit this flaw in the Efficient Market Hypothesis? For starters one can open a Yuan savings account in China. However, for most individuals this is not an option. For most investors the Market Vectors – Chinese Renminbi/USD ETN (NYSE:CNY) is the easiest route to take. Unlike the Rydex CurrencyShares ETF (Exchange Traded Fund) which physically own the currency in the form of an interest bearing bank deposit, the Market Vectors Chinese Reminbi ETN (Exchange Traded Note) is a note which does not pay interest. The note own futures contracts instead of the actual currency and are a liability of Morgan Stanley. Unfortunately, there isn’t a Yuan Currency ETF which currently exists. As long as Morgan Stanley does not go bankrupt the ETN is just as safe as an ETF without the interest payments.
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