On the first day of the U.S.-China Strategic and Economic Dialogue, Secretary of State Hillary Rodham Clinton and Treasury Secretary Timothy Geithner both quoted, remarkably, the same Chinese aphorism in their different speeches: "When you are in a common boat, you need to cross the river peacefully together."
Neither gave a fairly precise description of what they call common boat, but I don’t think it’s an overstatement to say that the big common boat has many public and private cabins. For now, let’s only take a short peek inside that cabin for the U.S. dollar.
Remember, earlier this year, Geithner branded China (unwisely but not inaccurately) a currency manipulator. It took China’s Premier Wen Jiabao until the beginning of March to reply by making some straightforward statements after the closing of China’s annual legislative session: “Of course we are concerned about the safety of our assets. To be honest, I’m a little bit worried … I would like to call on the United States to honor its words, stay a credible nation, and ensure the safety of Chinese assets.”
At the first day of the Strategic and Economic Dialogue that was initiated in 2006 by Treasury Secretary Henry Paulson, China’s Assistant Finance Minister Zhu said: "We sincerely hope that the U.S. fiscal deficit will be reduced year after year, according to the objectives of the Obama administration … China has a huge amount of investment in the U.S., mainly in the form of Treasury bonds … we are focused on the security of China's investments in the U.S."
He added, not surprisingly, that China favors a stable dollar.
The U.S. Treasury's coordinator for the dialogue, David Loevinger, didn’t give away much, saying: "We talked about China's exchange rate policy, they talked about their desire to reform the international monetary system, and I'll just leave it at that."
There is no doubt the Chinese will put pressure on the issue of U.S. currency and fiscal policy. In March 2008, after Chinese Premier Wen gave his forthright comments, we saw a significant shift in the level of verbal support for the dollar.
Maybe it’s equally important to recall that following a visit by Secretary Paulson to the Gulf region in late May 2008, a whole series of dollar supportive statements emerged, including several from President Bush and Fed Chairman Bernanke.
Perhaps the most interesting of these interventions was the comment from Secretary Paulson on CNBC on June 7, 2008. He said in very clear terms, "I would never take intervention in the currency markets off the table or any policy tool off the table. I just can't speculate about what we will or won't do."
Given the Bush administration’s antipathy towards interventionist policies, this seemed, at least in my opinion, very significant. I don’t think Secretary Geithner would hesitate to intervene either, verbally as well as factually, and most probably in coordination with other central banks to support the dollar, if needed, in order to not make things far worse as they already are.
It’s very simple: Firstly, nobody can profit from a collapse of the U.S. dollar, and secondly, nothing can replace the U.S. dollar as the main world reserve currency for now.
The Chinese, as well as others, have also learned not to shoot themselves in the foot anymore by making anti-dollar statements.
Notwithstanding, all this comes at a moment when the dollar is once again under mild pressure.
Since March 9, just a week ahead of the introduction of quantitative easing by the Federal Open Market Committee, the dollar index has started sliding, but has not collapsed, by over 12 percent with recently renewed moderate losses. This after a moderate move up in June and early July, over the course of the past three weeks.
That said, there is no doubt in my mind that the Chinese will discretely press for some form of renewed U.S. dollar verbal supportive intervention sooner rather than later. In fact, Philadelphia Fed President Charles Plosser, who will not be a voting member on the Fed's monetary policy-setting FOMC until 2011, has already started promising that Fed policy will act and react in a fiscally responsible way.
While Plosser isn't worried about inflation in the near term, he indeed does see inflation risks in late-2010 or 2011.
Commenting in The Wall Street Journal on how the Fed might withdraw its stimulus before the economy is clearly out of danger, Plosser said, "I think we've got a tough road ahead … I also don't want to repeat the Great Inflation of the 1970s."
So, it will be interesting to read the closing communiqué of the U.S.-China Strategic and Economic Dialogue that will be published later today as well as to hear what Secretary Geithner, Secretary Clinton, as well as Vice Premier Wang will say, or won’t say, in their press conferences.
In my opinion, the U.S. dollar index could, for now, continue to move quietly down to below 78.33, which was its low in early June. Ideally, if you would consider going long on the dollar, the U.S. dollar index should come under the Dec. 18 low of 77.69.
Yesterday, the 10-day average of the Daily Sentiment Index stood already at a record low of just 9.1 percent, which is in fact lower than it was on March 17, 2008 when the dollar index bottomed at 70.70 and the Daily Sentiment Index stood at 10.8 percent.
Thereafter we had to wait a while until the euro peaked in July 2008 before experiencing a nice rally that brought the dollar index right up to 88.46 in November 2008, which represents 25 percent increase in four months.
If you ask me, I wouldn’t be surprised to see something similar happen. Of course, past performances don’t guarantee at all future performances. Anyway, I wouldn’t bet against the dollar now. As I already said before, I think it could be 2008 all over again.
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