Saturday, October 10, 2009

Dollar Drags Yuan Down WIth It

The dollar is sinking. That tends to happen when you print vast amounts of your currency and drive interest rates to zero. Making matters worse, Australia and some others are starting think maybe it's time to start raising interest rates. Can you hear the great sucking sound of currency leaving the U.S.?

What no one seems to be talking about is the U.S. dollar is taking the Chinese yuan down with it. The dollar has not depreciated substantially against the Chinese yuan because Chinese monetary authorities won't let it do so. They have kept the exchange rate pegged at near 6.84 yuan per dollar since July 2008. That means as the dollar goes down it takes the yuan with it. The U.S. dollar has depreciated by about 13% against the Euro since February, but the yuan has depreciated by 13% against the Euro as well. That means bargain vacations at the Great Wall and cheaper adoptions of Chinese orphan girls for Europeans. But how can the currency of the country that supposedly is leading the world out of the recession (China) be depreciating? How is the trade deficit and its twin--the growing mountain of Chinese dollar holdings--ever going to go away if the yuan never appreciates against the dollar?

The Chinese leaders have painted themselves into a corner. They now hold huge dollar assets, so a depreciation against the dollar would cause them to lose huge amounts of money on their Treasury Bills and other dollar investments. So they can't break the dollar peg without impoverishing themselves. And the dollar peg combined with an unmitigated trade surplus means the Chinese keep piling up even more dollars. Meanwhile, one-in-ten U.S. workers is unemployed and we make less and less of our stuff at home. Where does this road lead?

Oh, and you say the dollar-yuan peg is not that important since U.S.-China trade is not that big. Well, not true, because China's competitors/traders are very conscious of how their exports are priced vis-a-vis China's, so they don't let the yuan devalue too much against their currencies. The yen has depreciated only 3.5% against the yuan since February.

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