Jumping Ship?

“Worry is the interest paid by those who borrow trouble.”

—George Washington


Making Demands With Little Leverage

Our regular readers know we’ve been focusing on the fading fundamentals backing the Dollar. And it’s getting more interesting… From Bloomberg:

“U.S. Treasury Secretary Timothy Geitner said China must let the yuan rise more quickly to show trading partners that it’s following through on its promises.

“Frankly they haven’t let the currency move very much so far,” Geithner said yesterday in an interview on Bloomberg Television in Washington. “They know they’re just at the beginning of that process and I think we’d like to see them move more quickly.”

Premier Wen Jiabao’s government has limited the yuan’s gain to less than 1 percent versus the dollar since a June pledge for greater flexibility. With November elections approaching, U.S. legislators have planned hearings on the topic and may push a bill to let U.S. companies seek tariffs in compensation for an undervalued yuan that makes Chinese goods cheaper overseas.

China tomorrow may say its trade surplus topped $20 billion for a third month in August. Exports exceeded imports by $26.9 billion, according to the median of 34 forecasts in a Bloomberg News survey. By contrast, the U.S. Commerce Department may today report a $47 billion deficit for July, a separate survey showed.”[1]

This is extremely intriguing. Actually it borders on the audacious when you really think about it. For starters, tariffs would raise prices for the already stretched U.S. consumer. The U.S. is also pressuring its largest lender who buys its debt at (what we believe are) artificially low interest rates due to the Federal Reserve creating trillions of dollars out of thin air to also buy the same U.S. debt to keep rates low vs. selling it all on the open market. At the same time U.S. monetary policy-makers continue to print/devalue the currency they’ll ultimately pay the Chinese back in.

We ask – under this scenario, why would China let their currency rise, hurting their exports in the process – when they are already funding a large portion of U.S. debt at low interest rates, and are likely to be paid back in Dollars which are worth far less than they are today. Would you?

Chinese-Russian Dollar Exclusion?

And it could very well be that China and Russia are getting close to bypassing the Dollar:

“China and Russia plan to start trading in each other’s currencies as the world’s second-biggest energy consumer and the largest energy supplier seek to diminish the dollar’s role in global trade.

China may start trading its currency against the ruble within weeks, three bankers with knowledge of the matter told Bloomberg, and sent out a document last week allowing lenders to apply for ruble trading licenses, one of them said. Russia’s Micex Stock Exchange is making preparations to trade the ruble against the yuan in an initiative that has the backing of the country’s central bank, Ruben Aganbegyan, the head of the bourse, told reporters at a conference in Moscow today.

“Given the risk to the dollar and U.S. assets from their fiscal position they want to reduce their dependence on the dollar as an invoicing currency,” Bhanu Baweja, global head of emerging markets fixed income, currency and credit research at UBS AG, said in a phone interview from London. “It makes sense for two large economies to exclude a third, overly dominant economy from their trading equation.”

In the wake of the global financial crisis, which forced the U.S. economy into recession, both China and Russia have called for the dollar’s role in the financial system to be diluted… President Dmitry Medvedev last year suggested Russia, holder of the world’s third-largest foreign-currency reserves, reduce its holdings of dollars…

China overtook Germany as Russia’s second-largest trading partner in the first six months of the year, helped by exports of Russian commodities such as aluminum, nickel and oil and gas. Trade between China and Russia jumped 50 percent to $30.7 billion in the first seven months of this year, compared with the same period in 2009, China’s Ministry of Commerce said in a statement on Aug. 21…

“Gradually the dollar is being eliminated from the foreign-trade settlement flows,” said Dariusz Kowalczyk, a Hong-Kong based senior economist at Credit Agricole CIB. “People are beginning to trade Asian currencies without intermediation via the dollar.”[2]

For a while we’ve wondered how long the world would tolerate poor Dollar fundamentals. The answer may be getting clearer.

While there is a lot of tough reality going on out there – we maintain our positive outlook. That outlook is based on our belief that a bear market in one thing is often a bull market in another.

As we enter this critical time – now, more than ever – we believe investors need to focus on their investment strategies. Those readers who are clients are fully aware of the strategies we’re implementing in light of unfolding economic circumstances. Others may feel free to contact us to learn more.

Sincerely,

Stephan R. Ernharth, JD
Vice President
Ernharth Group
www.ernharth.com

Go to www.ernharth.com/commentaries to read past articles from our Economic Commentary series.


1.Bloomberg, “Geithner Says China Needs to Let Market Drive Up Yuan”, September 9, 2010
2.Bloomberg, “Yuan Trading Against Russian Ruble Said to Start Within Weeks in Shanghai”, September 8, 2010