Most Popular
1. It’s a New Macro, the Gold Market Knows It, But Dead Men Walking Do Not (yet)- Gary_Tanashian
2.Stock Market Presidential Election Cycle Seasonal Trend Analysis - Nadeem_Walayat
3. Bitcoin S&P Pattern - Nadeem_Walayat
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
4.U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - Raymond_Matison
5. How to Profit from the Global Warming ClImate Change Mega Death Trend - Part1 - Nadeem_Walayat
7.Bitcoin Gravy Train Trend Forecast 2024 - - Nadeem_Walayat
8.The Bond Trade and Interest Rates - Nadeem_Walayat
9.It’s Easy to Scream Stocks Bubble! - Stephen_McBride
10.Fed’s Next Intertest Rate Move might not align with popular consensus - Richard_Mills
Last 7 days
Micro Strategy Bubble Mania - 10th May 24
Biden's Bureau of Labor Statistics is Cooking Jobs Reports - 10th May 24
Bitcoin Price Swings Analysis - 9th May 24
Could Chinese Gold Be the Straw That Breaks the Dollar's Back? - 9th May 24
The Federal Reserve Is Broke! - 9th May 24
The Elliott Wave Crash Course - 9th May 24
Psychologically Prepared for Bitcoin Bull Market Bubble MANIA Rug Pull Corrections 2024 - 8th May 24
Why You Should Pay Attention to This Time-Tested Stock Market Indicator Now - 8th May 24
Copper: The India Factor - 8th May 24
Gold 2008 and 2022 All Over Again? Stocks, USDX - 8th May 24
Holocaust Survivor States Israel is Like Nazi Germany, The Fourth Reich - 8th May 24
Fourth Reich Invades Rafah Concentration Camp To Kill Palestinian Children - 8th May 24
THE GLOBAL WARMING CLIMATE CHANGE MEGA-TREND IS THE INFLATION MEGA-TREND! - 3rd May 24
Banxe Reviews: Revolutionising Financial Transactions with Innovative Solutions - 3rd May 24
MRNA - The beginning of the end of cancer? - 3rd May 24
The Future of Gaming: What's Coming Next? - 3rd May 24
What is A Split Capital Investment Trust? - 3rd May 24
AI Tech Stocks Earnings Season Stock Market Correction Opportunities - 29th Apr 24
The Federal Reserve's $34.5 Trillion Problem - 29th Apr 24
Inflation Still Runs Hot, Gold and Silver Prices Stabilize - 29th Apr 24
GOLD, OIL and WHEAT STOCKS - 29th Apr 24
Is Bitcoin Still an Asymmetric Opportunity? - 29th Apr 24
AI Tech Stocks Earnings Season Opportunities - 28th Apr 24
S&P Stock Market Detailed Trend Forecast Into End 2024 - 25th Apr 24
US Presidential Election Year Equity Performance in the Presence of an Inverted Yield Curve- 25th Apr 24
Stock Market "Bullish Buzz" Reaches Highest Level in 53 Years - 25th Apr 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

China Knows the Fate of the Euro

Currencies / Euro Sep 05, 2010 - 05:41 AM GMT

By: Bryan_Rich

Currencies

Best Financial Markets Analysis ArticleThis week, the U.S. Commerce Department gave China another pass on its currency manipulation, ruling against charges it was undercutting U.S. aluminum makers.

This puts China’s currency back on the radar for the politicians and others who, last June, were coaxed into thinking that China was making concessions on its weak currency policy. That’s when China announced they would be de-pegging the value of the yuan from the U.S. dollar.


But all of the bad interpretations surrounding China’s move off of the dollar peg this summer clearly show how confused financial market participants are on this issue …

The mainstream opinion is that China folded to the pressures from the rest of the world. That it opened the door to a big yuan revaluation, which would ultimately allow the currency to appreciate to the market’s estimate of fair value against the dollar.

That’s roughly 40 percent higher than current levels — a move that would go a long way in helping rebalance the global economy, which would be good for long-term global economic stability and growth.

However, that would entail China slowing its own economy at a time when world economies are vulnerable, all for the benefit of others. Not likely.

Instead …

History Is a Good Guide for China’s Likely Course of Action

History shows us that China will continue to act in its own best interest by maintaining trade advantages. This, in turn, will allow the country to keep employing more of its billion-plus citizens, gathering global capital, and boosting its global economic prowess.

Just take a look at the recent history …

The chart below is the government-manipulated exchange rate of the U.S. dollar against the Chinese yuan. A fall in the exchange rate reflects a stronger yuan. You can see where China abandoned the peg against the dollar in 2005 (the red line) under the pressure of tariff threats by U.S. Congress.

Initially the Chinese government allowed the yuan to appreciate by 2.1 percent. In total, over the course of the next three years, the yuan gradually climbed another 15 percent against the dollar.

chart1 China Knows the Fate of the Euro

But you can also see in this chart, in late 2008 when the financial crisis was at its peak, China went back to a peg against the dollar (where the red line in the chart starts moving horizontally), which benefited them in two distinct ways  …

  1. It ensured that its most important consumer, the United States, would maintain its purchasing power, even as the U.S. dollar was retreating during much of 2009. And,
  2. Because of the dollar’s weakness, it created an even greater cost advantage in the global markets for China against its other Asian trading partners, whose currencies climbed sharply last year.

Now, after nearly two years of pegging their currency to the dollar, the Chinese are once again allowing some “flexibility” as they call it.

But there hasn’t been the major one-off revaluation of the yuan the markets have been looking for. Instead, as you can see in this shorter-term chart below, in the two months since moving off of the peg, the yuan strengthened only 1 percent against the dollar.

However, now that the world economic outlook has turned grim again, the yuan has reversed course against the dollar, weakening back toward the value of the recent peg.

chart2 China Knows the Fate of the Euro

Given the backdrop I described above, you might ask: Why would China alter its currency policy in the first place?

My guess:

China Wants a Euro Hedge

What’s likely factored most heavily into China’s new currency strategy is the dismal outlook for the euro. Europe is China’s biggest export market. And the falling euro represents a major threat to China’s exports.

The euro lost nearly 20 percent of its value against the dollar from November 2009 to June of this year. All the while, China’s currency was pegged to the dollar. That means European consumers lost significant buying power against not only the dollar, but also against the yuan!

And with the structural problems surrounding the euro, it will likely resume its steep decline and may even result in a break-up of the monetary union — an end to the euro.

China is a highly export dependent economy, and maintaining a cheap currency plays a huge role in their competitiveness. So a continued revaluation of the yuan against the euro doesn’t sit well, especially given the prospects for another global economic slowdown.

China switched to a basket of currencies to manage the yuan's exchange rate.
China switched to a basket of currencies to manage the yuan’s exchange rate.

That’s why China’s currency, under its new policy, trades against a basket of currencies, with about 60 percent less direct exposure to the dollar.

China wants its currency pegged to the dollar when the dollar is weakening. But they don’t want to be pegged to the dollar when it’s strengthening. And the latest policy dramatically diversifies away China’s exposure to a stronger dollar going forward — and consequently, the adverse effects of a weaker euro.

The key take away here: With the evidence of deflationary forces, depressed demand and the growing probability of double-dip recession, global central banks have been exposed as powerless to shorten what increasingly looks to be a long, drawn out period of economic malaise, fraught with economic shocks.

In that world, where sovereign debt defaults, global currency devaluations and a sustained safe haven rally in the dollar look likely, China has one goal: Protect its exports.

Regards,

Bryan

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.


© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in