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America's Failed Dollar Strategy, Greek Debt Crisis Will Slow the Yuan's Advance

Currencies / US Dollar May 05, 2010 - 05:11 AM GMT

By: Money_Morning


Best Financial Markets Analysis ArticleKeith Fitz-Gerald writes: Poor Tim Geithner.

Pushed by angry U.S. legislators anxious to brand China as a "currency manipulator," the U.S. Treasury secretary tried to strong-arm China into revaluing the yuan - all because of an assumption that the Asian giant wasn't allowing its currency to appreciate.

Unfortunately for Geithner, those efforts were stymied by a flood of data that actually demonstrates that China's currency has significantly appreciated against the already-wheezing greenback.

Never the quitter, Geithner next sought help from the Group of 20 as a means of turning a unilateral political issue into a multinational one (kind of like the Coalition in the Gulf War ... but with money instead of smart bombs).

Initially, India and the ministers were behind him. But when push came to shove, Geithner apparently lost his backing - judging from the fact that letting the yuan appreciate against the dollar wasn’t even mentioned in the G20's most-recent communiqué.

Now even the Greek debt crisis is working against the embattled Treasury leader and may actually short-circuit any possible hope that he could induce China to remove the yuan's currency peg against the dollar.

During the six-month stretch that ended with the close of April - right when Geithner was making his last-ditch pitch to the G20 - the yuan had soared by 12% against the euro. Meanwhile, there was a 3.01% gap in the "spot" versus "forward" rates in the yuan versus the dollar: The yuan ended April at about $6.62 to the dollar, meaning the greenback, in real time, is worth less.

Perhaps not surprisingly given recent events surrounding the Greek contagion, this suggests This means the euro is in real trouble and China has very little incentive to remove the peg to the dollar because of the dollar's relationship to that European currency.

As a case in point, while U.S. leaders were trying to jawbone their Beijing counterparts, the cost of credit-default swaps had skyrocketed, with traders demanding the highest yields seen in 10 months to hold Irish, Italian and Portuguese debt. According to CMA DataVision, contracts linked to Greek government bonds hit 821 basis points, up 111 basis points. At the same time As of last Wednesday , the yield on Portuguese debt hit 365 basis points, an increase of 54 basis points . (on the date I originaly prepared this article) .

Meanwhile, on this side of the Atlantic, U.S. Treasury yields fell into a ditch and dropped 12 basis points to 3.68% - representing the single-biggest decline seen in our paper markets since last December. As of yesterday (Tuesday), th e 10-year Treasury had fallen an addition al nine basis points to 3.59% - suggesting that everything we 're talking about is increasing in urgency. again this is dated)

Remember, prices and yields move in opposite directions. This tells us that even though much of the world has questions about our policies, they still love our U.S. Treasury debt when the going gets tough.

The risk of a sovereign-debt default is rising in Euroland - most notably for Greece and Portugal: Greece's debt was cut to "junk" status by debt-rater Standard & Poor's, which slashed Portugal's debt-rating, too.

But the fallout from such an event might surprise you: It's actually going to induce China to hold the line and not revalue its currency. I can even give you two reasons why:

•First, the free markets are already doing that for China.
•And, second, Beijing knows there is substantial volatility ahead because the recovery is nowhere near as solid as the world's central bankers want us to believe.
China is not about to do anything to upset the global apple cart. A stronger yuan - in excess of what the world currency markets have created on their own - would make China-made goods less competitive. And it would further eviscerate the already-devastated euro.

Further, Thus, removing the yuan's peg to the dollar would actually hammer the U.S. economy. What the "Buy American/China is a currency manipulator" crowd still doesn't get is that China's cheap labor pool and currency peg has served as a global-economic safety valve that has absorbed the hyper - inflation created by the issuance of $14 trillion in post-financial-crisis debt.

If you ask the question, "What hyper-inflation are you talking about?" ... well, you just answered your own question. There isn't any. And that's because of how China has handled this "crouching dollar/hidden yuan" controversy that virulent hyperinflation has yet to take hold .

This is not a popular viewpoint, I know.

But believe me when I tell you that it's the truth.

There's a bit more of this controversy that needs to be set straight, too. Despite the tremendous political snow job to the contrary, the so-called "cheap yuan" is not responsible for the loss of American jobs. And revaluing the China currency will not make the U.S. economy any stronger, or accelerate the pace of the post-financial-crisis recovery.

In fact, as I've demonstrated repeatedly during the past 12 months or so, just the opposite is true.

I've got to imagine this is giving Geith n er fits as the market points out the obvious and reality sets in. But there is simply no incentive for Beijing to remove the currency peg when the very currencies that China views as important to its trading relationships are as fragile as the economies they represent.

Treasury Secretary Geithner makes the case - as does the International Monetary Fund (IMF) - that having China revalue the yuan would help put the big chill on "excess demand pressures." But until the world decides it no longer wants to buy what China has to offer, this revaluation makes no more sense than his argu e ment .

Deficits do not reflect bad currency policies. They reflect the fact that the world is all too happy to purchase billions of dollars in Chinese manufacturing capacity, services and products.

It's worth noting that nobody thought this was a bad idea when times were good and the benefits of having done so went right to the bottom line.

[Editor's Note: A veteran trader, skilled analyst and noted market tactician, Money Morning's Keith Fitz-Gerald is able to see through the confusing haze of today's quickly changing markets in order to visualize and understand what the market really holds.

This ability to see into the future, and to predict looming changes - while also divining the profit opportunities those changes will create - is one of Fitz-Gerald's greatest strengths. It's a big reason that he's now a perfect 23 for 23 in his Geiger Index advisory service. If you would like more information about the Geiger Index, please click here.]

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Money Morning/The Money Map Report

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