Global Currency Armageddon to continue… (Part 1)
3/9/2011 7:22:47 AM -
In the next years starting in 2011, the currency Armageddon between China and the rest of the world (the United States at the front) is set to continue. Factions involved in this confrontation are expected not to back-down on their intransigence or demands because of the economic problems or better still trade imbalance currency discrepancies is creating among the nations. China to maintain its lead as the locomotive engine driving the world economy may not yield to any more calls for substantial revaluation of its currency the renminbi-RMB (the unit being the yuan) with proclivity of reducing its global competitiveness and supremacy. In nominal and purchasing power parity (ppp) terms, China is the second largest economy in the world after the U.S. Besides, it is the world's fastest growing economy with a growth rate of about 10%. The exchange rate of the RMB to the dollar is 6.6494 (November 25 2010). Nevertheless in real GDP terms, the economy of the U.S (real GDP $14256 billion in third quarter of 2010) is about three times that of China ($4909 billion in third quarter of 2010).
Despite these statistics, the United States and the EU with its expansive deficit problems are pressing ahead to see leverage in global trade so as to curb it growing deficit. As at the third quarter of 2010, the U.S debt was over $13.5 trillion which is about 94% of the GDP ($14.7 trillion third quarter 2010). The debt which is made up of two-thirds public debt namely in Treasury bill, notes and bonds is said to have spiked from 51% of GDP in 1988 to its current state of approaching 100% of GDP. Now, China circumspectly appears to be on the defensive whiles the rest of the world led by United States is on the offensive. Furthermore, China is not likely to succumb to the offensive tactics being applied by the United States and other large economies due to some intrinsic reasons.
Coming to think of it there are numerous reasons that go to expound the complexity of this currency war and to reveal the difficulty in dealing with this problem. In terms of longevity, this currency war is here to stay and the world should be bracing for long term strategies that can gradually deal with it without any despicable spill-over effects. This article would like to throw some light on some six(6) reasons why the currency pressure on China may not produce the expected impact in terms of leveraging trade imbalance (or balance of payments) and economic growth horizons. The six (6) reasons are classified into (1) Capitulating developments (2) Extrinsic Austerity measures
1. Revaluation of China's currency since July 2005 by more than 22.2% has not worked to reduce substantially the widening trade imbalance or balance of payment between China and the U.S. and other developed countries. As at the third quarter of 2010, the current account encompassing balance of trade for some contending developed economies stood at: U.S -$127. 2 billion, EU -$25 billion, U.K -$10 billion, Germany $14 billion, Japan $1436 billion whereas that of China was $70500 billion. Though in October 2010 for the first time since 2007, China shocked the world market by increasing the deposit and lending rates to about 5.56% it did not reflect in the trade imbalance differential. Perhaps this action was to cool its heated economy and curb inflation which stood at 5.10% with a jobless rate of 4.20%. Obviously, this move has no direct quantifiable effect on currency revaluation and consequently on the increasing trade imbalance between China and the United States or western style economies.
2. The falling value of the dollar is what some nations of the world are waiting for. A fall in the value of the dollar is seen as loss of U.S global economic power and somehow military power. It is also seen as a transfer of power from the Western to the Eastern world and a defeat to capitalism. Opponents of the dollar still being used as the world reserve currency in spite of its fall are energized by these developments to argue their case out for a new world reserve currency. They view these developments as a loss of confidence in the U.S economy to lead the world economy and a justification for new world economy leader and world reserve currency change by the Central Bank. Just as they may have a case, replacing the dollar with another currency may not solve the world's economic problems. Why? In the opinion of this writer, the solution for leveraging the trade imbalance is to have one currency for the world which may call for the creation of one government perhaps to be followed by one religion. Such developments may conform to biblical prophecy revealed in the book of revelation. In fact, no currency will be sustainable in the long term with respect to unyielding to global economic pressure. So even if the dollar is replaced with another currency such as the Euro, the problem of currency degeneration and the global economic instability will continue unabated. Meanwhile, It is possible that if the currency war perpetuates in the long term a new world order will emerge as world economies will gravitate towards one world currency leading to one government and perhaps one religion.
3. China has huge foreign exchange reserve which makes the country powerful even though such immense reserve has repercussion of triggering inflation locally. Perhaps, this may have been the cause of the 2010 interest rate augmentation by the Chinese government. As at September 2010, foreign exchange reserves for China was $2648.3 billion as against that of the U.S. which was $129 billion (July 2010 estimates). With huge foreign reserves equated to economic power, China has the ability to buy dollars which is a convertible currency as against selling their currency renminbi-RMB (the unit being the yuan) which is not easily convertible. Consequently, the Chinese government can continue to buy the dollars to maintain the dollar's appreciation as against the depreciation of its currency unit (the yuan). In fact China's large reserve has some advantages as well as disadvantages. The large reserve of foreign currency allows the Chinese government to manipulate exchange rates - usually to stabilize the exchange rates and provide a more favorable economic environment. This means the country is in a better position to defend its domestic currency (the yuan). It also authenticates China's ability to pay its foreign debt thereby strengthening its high credit rating. However, such large reserve in U.S. dollar-dominated assets (U.S. bonds and dollar currency) is risky if the U.S. dollar weakens and the country's debt mountain grows. Ultimately, there could be relative loss of wealth as a result of the weakening dollar and increasing threat of default in repayment. The option for China to deal with this risk is diversification of its foreign exchange reserves. Consequently, the country has resorted to converting some of its foreign reserves into gold reserves thereby increasing the safety of its foreign exchange reserves. The decision of China recently to increase its gold reserves as against holding dollar reserves is gradually producing a resonating effect of a steep rise in gold price on the world market. In fact there is a negative correlation here between the rising price of gold and the weakening of the dollar. That is as the dollar weakens gold price generally rises. The explanation for this trend is that as the dollar weakens, investors are moved to diversify their risk. Ultimately, they will resort to buying gold reserves so as to have a safety seat for their wealth creation. Additionally, the Chinese government and investors diversification into gold to protect their wealth is contributing immensely to the rush for gold invariably helping gold mining companies to accrue huge profits. Unfortunately, analysts do not know when this diversification will be curtailed and this suggest gold futures will continue to be on the ascendency. Nevertheless, investors should take a scrupulous second look at investing in gold if they want to continue their wealth creation and not be caught off guard. The fact is countries with huge gold reserves at some point in time may decide to flood the market with bullions, producing a breaking effect on the price and subsequently bringing it down. Another interesting safety action China has embarked on is to diversify its foreign exchange reserves risk through debt auction by buying treasury debts of some trusted credit-worthy countries such as Japan and some EU member nations. This is interesting because China has decided to buy the treasury debt of Spain in spite of the fact that Spain is on the bail out list of EU. China believes in the success of the economic reforms being pursued by these countries with whom they are engaged in the debt transaction. That is why China is resolute in pursuit of these risky debt transactions. However, there is no guarantee that reforms by these nations will succeed as the EU member debt crisis is not over and is likely to spread. Stake holders know that it is risky deal yet they are going ahead with it. Unfortunately such debt transactions can ignite an 'economic bubble burst' for China which may spread to the whole world regenerating another global financial meltdown.
4. The currency war is not only about China since there are other countries such as Japan whose currency the yen is devalued. Since it is a convertible currency, it is easy to manipulate. Japan with a GDP growth of 1.10% (3rd. quarter), interest rate of 0.00%, inflation rate of 0.20%, jobless rate of 5.10% and balance of payments of $1436 billion has the capacity to manipulate its currency also. As at third quarter of 2010, the yen was being traded around 83 to the dollar. Unfortunately, China is seen as the only culprit in the currency manipulation issue. In fact, there are a host of countries involved in this act which is adding to the global trade imbalance. Every one of those countries involved has subtly taken advantage of the sticky situation to stay competitive globally whilst China bears the scolding and pressure.
In concluding the capitulating developments on the currency war, it can be deciphered that the current currency war is more complicated and profound than is considered to be. The problem is not between the United States and China. It is more than China revaluing its currency or the global currency being replaced or leverage in trade imbalance. Consequently, it may be difficult to solve in the short term and so the world must expect more of the impasse in 2011. See part 2 of this article for the rest of the analysis.
Author: Charles Horace Ampong