Yuan Rises, Dollar Falls To New Records
The Chinese yuan has surged to new highs against the
US dollar on Singapore's forward markets on fresh speculation
that Chinese officials will revalue the currency upward
against the US dollar. Prices on the market imply the
expectation that the yuan will trade at 7.937 yuan to
the dollar in 12 months, or a rise of 4.3%.
The yuan is not the only currency to rise against the
dollar. The dollar fell to a new low against the euro
of 1.2927 today on currency markets.
As the Bush administration plans for its second term,
it is faced with an urgent need to finance record deficits
as it domestically cuts taxes. Vice President Cheney has
publicly stated that deficits don't matter, but many economists
don't share that view. Seventy percent of US economic
activity is based on consumer spending, and for the past
several years, US consumers have been living and spending
beyond their means, digging into their savings to cover
their spending.
On a national level, the US has depended mainly on the
Chinese and Japanese central banks purchases of US treasury
bonds to finance its deficit. A revaluation of the yuan
upwards would amount to a devaluation of these bonds for
the Chinese.
However, the US is limited in how much it can raise interest
rates, as that would hurt domestic US activity, and consumer
spending in particular. The US will have to use all means
at its disposal to get Asian central banks to continue
financing its deficit until US productivity and economic
activity rises.
There are signs though, that the Asians want to cut their
reliance and exposure to the US economy. The euro is now
an attractive international reserve currency compared
to the US dollar. On the trade policy front, the Asians
are continuing to work on free trade agreements (FTAs)
within the Asian zone, which will reduce their dependency
on the US economy.
Since the Asian economies, with China in particular,
are now the engines of world economic growth, a sizable
part of the second Bush administration's time will be
spent on convincing international institutional investors
why they should continue to finance US debt at favorable
terms.
If the US is unable or unwilling to offer more attractive
terms on dollar-denominated debt, it is likely that the
Asians will seek to reduce their dependence and exposure
to the US economy, both on the currency and trade dependency
levels. Overall, this may lead to a disengagement of the
US economy from the European and Asian trading blocs.
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