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Whatever Happens, US Dollar Won't Be Boring

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Tuesday, 02 Nov 2010 12:13 PM Current | Bio | Archive

We got a surprising statement Monday from the Chinese Commerce Ministry that seems to paint a not-so-cordial picture of United States—Sino relations.

In a report on its website, it states: “The currency war is intensifying … In the midterm, the dollar will continue to weaken and gaming between major currencies will escalate, increasing risks for businesses and affecting global trade development.”

Vice Commerce Minister Chen Jian also said that the recent appreciation in the yuan doesn’t indicate any policy change related to trade and investment.

He noted that broad dollar weakness has increased upward pressure on the yuan. He added that yuan appreciation may be beneficial for outward investment but it might hurt exporters.

Also interesting were some statements of Zhou Qiren, who is an academic adviser to the People’s Bank of China (PBOC) and a professor at Peking University, in the Shanghai Securities News. “The biggest problem in the yuan formation mechanism now is the central bank. In order to keep the exchange rate stable, it is buying a huge amount of foreign currency every day and creating base money,” he said.

All this appears to mean that, once again, we are walking in circles and making no progress in resolving the Gordian Knot of these still worrisome rising global imbalances. Yes, it doesn’t look promising.

The statement that currency wars are intensifying is really surprising in view of the apparent sense of cohesion that was conveyed by the G-20 accord.

The deliberate use of this emotive and politically charged wording by the Chinese Commerce Ministry is undoubtedly a clear demonstration that certain, but not all, departments within the Chinese government have little faith in Treasury Secretary Timothy Geithner’s ability to effectively change the weakening of the dollar, which is understandable.

I think that direct dollar-buying intervention will probably be the only viable means for the U.S. Treasury to send a timely signal that it is an active participant in a new regime of international cooperation.

General expectations point to a more moderate approach to quantitative easing. If this is the case, investors could see some pressure removed from the dollar.

However, this could rapidly turn into a somewhat tricky situation because once this impact is felt for a short time, I can’t imagine sustained longevity in any dollar recovery while U.S. “real” interest rates remain in real negative territory.

Remember, the 35 percent decline in the dollar index since 2002 coincides with negative real interest rates over that same period thanks to Alan Greenspan and Ben Bernanke.

If you ask me, and because of such an open and disobliging criticism from China that is one of the key players in the ongoing intrigue of global imbalances, there is no doubt in my mind that the latest G-20 rhetoric that came out from South Korea will go the same way as all of its predecessors.

No, happy days for the dollar aren’t here again. But we shouldn’t exclude a possible dollar rebound. We will have to keep a close eye on what will happen. Surprises can’t be excluded at all.

Finally, if (and that’s a big if) the United States would be unable to provide meaningful support for the dollar that will have to include intervention, then it becomes more and more unlikely that China will make any further concessions with regard to its own currency policy in the foreseeable future and currencies wars will really take off.

Indeed, the PBOC has continued to fix the yuan steadily weaker during the past week, as it has done since mid-October despite the weakening dollar index.

If this is the case, then it also seems reasonable to suppose that the grim dynamic that has dominated currency trading since mid-September is likely to kick in quickly again from here.

Indeed, capital flows as observed in New York suggest that this is exactly what is happening for the time being. In the aftermath of the meeting of G-20 finance ministers and central bankers, we saw four days of net dollar buying, at least as noticed in the N.Y. capital flows.

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We got a surprising statement Monday from the Chinese Commerce Ministry that seems to paint a not-so-cordial picture of United States Sino relations. In a report on its website, it states: The currency war is intensifying … In the midterm, the dollar will continue...
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2010-13-02
Tuesday, 02 Nov 2010 12:13 PM
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