Is Chinese Currency Compromise Setting the Agenda for a G-20 Debate?

by: Ralph Shell

Over the week end, the Chinese indicated they would permit a gradually floating yuan versus the USD, provided it did not change more than .50% per day. The markets initial reaction was as expected, a round of appreciation for the commodity currencies, and a stronger yen since the Chinese are the largest export market for the Japanese. The yen has since turned around and is now trading lower versus the USD.

Timing of the policy change on the eve of the G-20 meetings is curious. Politicians desire to keep their power, and the Chinese are aware of the current labor unrest. Enhanced purchasing power because, of the stronger currency and the availability of more consumer products goods may appease the unhappy workers, but is their more to the move?

It seems the Chinese, with their $1T portfolio of US Treasury debt, are fearful it may lose value if the dollar depreciates. The Asia Times Online this morning in an article called 'G-20 split and out of order', by Hassein Askan and Noureddine Krichene had these comments:

"The United States does not feel compelled to develop exports to pay for imports, instead letting the dollar's reserve currency position do the heavy lifting... But, ahead of the Toronto summit, the Barack Obama administration stands alone, calling for continued stimuli and more deficits to prevent the recovery from stalling. By urging more and more of the same, more deficits and higher debt, the Obama administration is in danger of being voted out in two years."

Another problem confronting the US economy and the value of the USD is the sophomoric dream that green energy and green jobs will fix the US dependence on foreign oil. It will not of course, but how much would US energy independence elevate the value of the dollar? And what penalty are we going to pay as the administration interferes with the 20% supply of our oil that comes from the Gulf?

The saga of the government's reaction to the oil spill continues to portray both parties poorly. As Larry Kudlow complained in a column last week:

"Look, at least BP already agreed to pony up. Why should the government control this? Isn't this another case of the Obama administration bullying, taxing and regulating business as part of a social agenda to redistribute income and power from private enterprise to government? It's a war on profits and capital.

Consider this: American companies are sitting on an astonishing pile of $1.5 trillion in unused cash. Why aren't they investing to create new jobs? Well, it's because massive tax and regulatory threats coming out of Washington have created a tall barrier of disincentives and uncertainty that is blocking the normal efficiency of the free-market capitalist system."

As mentioned the yen behavior has been baffling to us today. The yen versus the USD shows signs of coming out of a triangle formation to the downside but so far has only teased the yen bulls. Small spec short positions are large but perhaps commercials are there to sell strength. The CAD/JPY chart looks interesting. This cross trade is not for the faint of heart, so it is best to get your position on at the right price. Try to buy the C$ versus the yen at 87.50 for a return to the 90 handle.

Disclosure: Long FXA and FXY