Spring has Spring but No Thaw in US-China Relations

The US political pressure on China will heat up in the coming weeks. The pressure will likely culminate in May with the US Treasury formally citing China as a manipulator in the currency market. Anticipation of further appreciation of China’s renminbi is likely to help underpin other currencies in the region and help draw investment into the regional equity markets.

Ironically, but not coincidentally, the heightened pressure that will be brought to bear on China will take place as the renminbi’s appreciation has accelerated. In the first couple months of after the revaluation and shift to a basket approach, the yuan hardly moved against the dollar. In November 05 through January 06, the dollar fell about 0.1 renminbi a month. The pace doubled in February and quickened further in March with roughly a 0.3 renminbi move since the middle of the month.

Why the SDR is DOA

The recent discussions of the IMF's Special Drawing Rights needs to be placed within the context of the current profound crisis and calls for a new financial architecture.

At least four months ago George Soros (and others) proposed an increase in SDRs to help provide sufficient liquidity to arrest the deflationary forces that were growing. Ironically, China and Russia, apparently inspired the by famous speculator, have gone even further. A combination of nationalism and traditional realist balance-of-power politics, lies behind their arguments to grow the SDRs into a super-reserve currency that goes beyond supplementing the dollar and seeks to supersede it as the world’s reserve asset.

CNBC: New Global Reserve Threat to Dollar

Dollar Wobbles

The U.S. dollar has been beaten back in recent days and the perma-bears are taking to the airwaves. They attribute this decline to the Federal Reserve’s decision to increase its balance sheet by $1.15 trillion. While the dollar fell hard on the unexpected news, the fact that it’s decline began some time prior to the Fed’s move, suggests a more nuanced understanding of the price action is necessary.

A look at the euro will illustrate this point. On March 4th it recorded year to date lows just under 1.2460. It then proceeded to recover strongly. For a run of seven sessions, it did not take out the previous day’s low. That streak ended on March 16th, but then resumed.

Fed Preview: More Talk, Less Action

The FOMC meets on the 17th and 18th of March. While there is speculation of new measures, including the outright purchases of Treasuries, the probable outcome is more subdued. More likely than buying long-dated Treasuries, the FOMC could announce increase in its size or scope of buying mortgage-backed securities.

The Fed’s economic assessment is unlikely to change much. There are some positive signs emerging, but they are too preliminary for the Fed to do more than recognize in passing, but can be a source of optimism going forward. It appears, for example, that consumption may contribute positively to 2009 first quarter GDP for the first time since the second quarter of last year. The continued unwinding of the unintended build up of inventories is also a necessary precondition for increased output.

Who Watches the Watchmen?

Experts told us that the odds of what is currently happening were so infinitesimally small, it was more likely the sun fail to rise in the sky tomorrow. And yet here we are. Surely, we should be suspicious of their diagnosis and subsequent policy prescriptions, but despite the political paralysis, there seems to be nearly universal agreement.

Informed by monetarist analysis of the Great Depression, conventional wisdom holds that credit needs to be restored and by definition, that will resolve the economic crisis, which is understood as a credit crisis. The credit spreads, we were told, are a measure of the patient’s fever. Alan Greenspan identified the LIBOR/Overnight Index Swap (OIS) as such a measure, others cite the interest rate differential between U.S. T-bills and Eurodollars.

Sun Rise, Sun Set

The decline of the yen in recent weeks is the most dramatic development among the major currencies. Previously, and frustratingly for Japanese officials and businesses, the yen was the strongest currency. From its summer high through late January, the dollar fell almost 22% against the yen. The euro and sterling’s decline was even more precipitous, falling roughly 34% and 46% respectively against the yen. On a trade-weighted basis, the yen appreciated by 35%. This is an exchange rate shock of incredible proportions.

The good news is that the yen’s bubble appears to have popped. The reversal of the yen’s fortunes is instructive. First, like the financial crisis itself, few could envision the end of the yen’s advance. Yet it has happened and without a clear cause. Some want to link the yen’s decline to Japans horrific fourth quarter GDP report, which revealed that the world’s second largest economy contracted at an annualized pace of 12.7%. However, that report was released on February 15, three weeks after the dollar and euro had already bottomed on January 21st.