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US, China Trade War Is More Than a Game of Chicken

Monday, 27 September 2010 10:33 AM Current | Bio | Archive

So here we go ...

The Chinese Ministry of Commerce said that it will impose an anti-dumping duty as high as 105.4 percent on U.S. broiler chicken products effective today.

Also today, Xu Nuojin, deputy head of the People's Bank of China (PBOC) in Guangzhou said: “Any efforts to address the international payments balance by adjusting the CNY exchange rate will achieve no results.”

And Vice Commerce Minister Chen Jian said that the House of Representatives Ways and Means Committee's approval of a bill on China's currency is “redundant” and that China will set policy on its currency according to its “own” needs.

Meanwhile, the U.S. Congress is trying to tighten fiscal policy via a consumer-sales tax. The House Ways and Means approved an act to impose tariffs on China, which, in my view will be a tax on U.S. consumers.

Yes, we could say the U.S.-China “Chicken War” has begun…

Throughout the last 40 years, we have seen on a global scale politics and currencies being increasingly closely intertwined. As an example of this, we all remember the battles between Japan and the U.S. in the late 1980s and early 1990s.

Indeed, it is hard to see how it could be otherwise. However, one of the most notable changes in the currency markets since 2001 has been how this interrelationship has become a central, if not dominant, theme.

As proof of this, we need look no further than the astonishing growth seen in the size of global foreign exchange reserves during the last nine years, rising from just above $2 trillion to just below $8.3 trillion.

And yes, these reserves did not grow at an average of $63 billion a month by accident but, rather due to deliberate decisions made in both the developed and developing world on currency policies.

As has often been the case over the past decade, the period since the beginning of this month of September has seen a fresh flare up in these political tensions, with Japan’s decision to re-enter the currency markets in the immediate aftermath of its Democratic Party of Japan (DPJ) leadership contest and domestic political pressures ahead of the U.S. mid-term elections on Nov. 2 acting as a double flash point for renewed conflict.

The last seven days has seen a marked intensification in activity on a number of fronts.

I thought it could be helpful to investors to analyze this situation if they are to understand how the currency markets are likely to react:

First we have the US: Although not an issue of currency policy, there is evidence that quantitative easing (QE) policies have proved significant drivers for the foreign exchange markets when they have been deployed over the past decade. In light of this, the outcome of last week’s Federal Open Market Committee (FOMC) meeting takes of particular significance.

Although the policy committee did not introduce any new measures, the statement was changed to make it clear that the committee was “prepared to provide additional accommodation if needed to support the economic recovery.”

In clear English it appeared that the debate over QE2 that started to emerge through August was reaching a conclusion.

This view was given further credence on Friday by Federal Reserve Chairman Ben Bernanke when he stated: “Although financial markets are for the most part functioning normally now, a concerted policy effort has so far not produced an economic recovery of sufficient vigor to significantly reduce the high level of unemployment.”

Here, I must stress that I do not think the FOMC is making a move to deliberately weaken the dollar. It is also worth reiterating that U.S. dollar policy remains the remit of the U.S. Treasury. Nevertheless, it is likely that most members of the committee understand that the dollar will remain under pressure as a direct result of talk of any kind of second round of quantitative easing (QE2).

More pertinently, it seems reasonable to say that officials in Japan, China and, arguably, even Europe will see this recent talk as evidence that U.S. authorities are reverting to a policy of “benign neglect” towards the dollar.

Secondly we have Japan: With the dollar under renewed pressure since the FOMC meeting last Tuesday, the Ministry of finance (MOF) will increasingly be aware that they may need to step into the market again if they are to prevent a fresh attempt to challenge the all time low of 79.70 Japanese yen per dollar.

If they do so, then they must balance the need to strike fear into the market against the risk of exciting official complaints from overseas governments that the Japanese authorities are “manipulating” their currency.

Given this, they will certainly take into account the relatively muted response seen to whatever happened on Friday morning. They will also factor in the fact that the U.S. administration has gone out of its way over the past two weeks to not level any criticism at Japan currency intervention. Indeed, in New York last week, Prime Minister Kan and President Obama didn't mention intervention in their talks last Thursday.

I agree, we can only speculate why this is the case, but we must nevertheless admit that such a move by the U.S. would be logical if it is looking for allies to tackle China on currency policy matters at the upcoming G-20 meeting that will take place in Seoul, South Korea, on Nov. 11–12.

If true then this would, presumably, give a cautious green light to Japan to continue trying to draw its line in the sand. Adding it all together it seems reasonable to me supposing that the Japanese MOF will make a further, robust, foray into the currency markets should the dollar continue its slide.

Thirdly, we have of course China: No doubt China is perfectly aware of the forces mounting against it. In hindsight it looks increasingly likely that the reason why China allowed its currency, the yuan to start appreciating at the pace it did at the beginning of this month at the moment that Larry Summers warned them, during his visit to Beijing, of the growing pressure being brought to bear upon President Obama to be seen to take some meaningful steps ahead of the mid-term elections on Nov. 2.

Undoubtedly, Larry Summers highlighted not only the fact that the currency manipulation report is due on Oct. 15 but also the moves that are taking place within the House.

Unfortunately, it now looks as those efforts to avoid a conflict may already be foundering. Following the “candid” two-hour meeting in New York last Thursday between President Obama and Chinese Premier Wen where the Chinese currency, the yuan was reportedly a central topic, and the action by the House Ways and Means Committee on Friday and the House now likely to vote positively on the bill this week, China has decided react in kind the way they see it.

Not only has the Ministry of Commerce imposed anti-dumping duties on U.S. broiler chicken products but it is also noticeable that the PBOC pointedly fixed USD/CNY significantly higher this morning.

Finally we have the eurozone: In my opinion it’s safe to say that if the dollar and the yuan (CNY) are likely to slide and the Japanese yen (JPY) is in some way “effectively pegged” to the dollar, then the euro is most likely to benefit from the interplay of these huge global currency forces, which would be an exact “replay” of what in fact it did in 2002 under very similar circumstances.

This could come despite the fact concerns over peripheral sovereign debt continue to mount as can be seen from the recent movements in Irish/German spreads along with the cost of the Irish five-year CDS and the revelations in the Wall Street Journal of the depth of the political divisions within Europe in the run up to the crisis in May with splits that are no doubt still here beneath the surface.

Therefore it seems, at least in my opinion, reasonable to suppose that EUR/USD could make fresh gains as the new week gets under way.

However, I must say that I have great difficulties to recommend buying the euro given the structural problems that it still faces. Moody's Investors Service just downgraded the senior debt rating of Anglo Irish Bank Corp. Ltd. by three notches to Baa3/Prime-3 from A3/Prime-1 and maintains it on review for possible downgrade.

At the same time, Moody’s also downgraded the dated subordinated debt held by Anglo Irish by six notches to Caa1 from Ba1 and assigned a negative outlook.

Little surprise either that I continue to favor gold, notwithstanding that the Gold Miners Bullish Percent Index has reached the “critical overbought zone.”

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So here we go ... The Chinese Ministry of Commerce said that it will impose an anti-dumping duty as high as 105.4 percent on U.S. broiler chicken products effective today. Also today, Xu Nuojin, deputy head of the People's Bank of China (PBOC) in Guangzhou said: Any...
Monday, 27 September 2010 10:33 AM
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