Additional Thoughts on the RMB Repeg

I want to clarify something I wrote yesterday.

When I wrote "In the meantime the bands are playing and the trumpets are blowing as if this will solve some problem or other", I meant to say "US Problem". Perhaps it was obvious, perhaps not since I was questioned about it on Silicon Investor.

It will do little to help with the US current account balance, US deficit spending, US Congress spending like drunken fools, a savings deficient US, outsourcing of jobs, or for that matter much of anything else. Attempting to solve the world's trade imbalances with currency moves alone will prove to be futile. At 20-1 wage differentials it is just not possible. The US needs to stop living beyond its means, and it will be sad if the US thinks the job is now done and results will come pouring in as long as China keeps increasing the value of the RMB.

That said, stopping a global protectionist nightmare in and of itself was significant. China took a step closer to floating the RMB and hopefully this will quell the discussion as to whether or not China is a "currency manipulator". It may put some pressure on the US$ but that is by no means assured in the long term. As long as the US is hiking, I believe the US$ is likely to have a decent bid.

Perhaps that is one reason China acted now. If so, China's timing was perfect. Acting now before the FED pauses on a housing bust was a very good move. Indeed, Stephen Roach proclaims An Awesome Move by China.

China’s long-awaited currency adjustment is unambiguously positive for the global economy. Yes, it is a first step -- and a tiny one at that. But it qualifies China as an active participant in the global adjustment process. Up until now, the Chinese were on the outside, looking in, insofar as global rebalancing was concerned. That was a recipe for increased trade frictions and protectionism -- a hugely destabilizing possibility for an unbalanced world. China’s move on the currency front diminishes those risks and could well provide an important kick-start to an increasingly urgent global rebalancing.

I applaud China’s action for three reasons: First and foremost, it derails Washington’s protectionists and the serious threat they posed to geopolitical stability. Admittedly, a 2% revaluation of the renminbi stops well short of the 27.5% adjustment stipulated by the proposed China Currency Act (S. 295) sponsored by US Senators Schumer and Graham.

A second reason why this action is a plus is that a small currency adjustment does little damage to China export competitiveness. China has already taken actions to cool off its overheated property sector, and it does not want to risk overkill by crushing exports.

Thirdly, China’s new currency policy is a much more stable arrangement for the world financial system. From the Chinese perspective, it will help relieve the tensions that have been building from failed sterilization tactics -- the inability of China to issue enough domestic debt to offset the massive purchases of US Treasuries required by the now-abandoned dollar peg. This was leading to excess money and credit creation -- underscoring the mounting risks of inflation and/or asset bubbles.

Roach concludes:
Let’s give credit where credit is due -- always a hard thing for the world when it comes to China. My advice is to look at what now lies ahead: Do not focus on the 21 July action as the end, in and of itself. While this first move was small and belated, China’s currency adjustment is emblematic of an endgame that could be a linchpin to long overdue global rebalancing. This is awesome news for an all-too-precarious world.

The logical conclusion is that one has to tip the hat to China for when they did it, how they did it, and with how little the initial impact was. China acted with class, unlike some counterparts here in the US.

Will this pressure interest rates in the US? Treasury bears and US$ bears sure think so. They came out of the woodwork to celebrate the demise of US treasuries and the US$.

The initial response was mild: 10 basis points on the 5-yr, 10-yr, and 30-yr notes. Significant but hardly a panic collapse. One day after the event, at least as I am currently typing, treasuries have gained half of that back. The Yen moved about 2.5% on the news but I see it has given back .8% of that. The US$ index is also up about .8% at the time of this writing as well. At least as of now, we have not seen any significant follow thru in relation to what everyone seems to be expecting.

That said one day does not prove much. Is this a profit-taking lull before the storm? Possibly, but if China moves slow enough, perhaps there is no storm. Indeed, perhaps we have already seen the bulk of the reaction with a near 50 basis point jump in the 10-yr note from Bill Gross's capitulation to the spike on the RMB announcement. If that is indeed the case, treasury bears shorting here after this significant move in rates over the past month or so just might be setting themselves up once again to have their heads handed to them.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/