Geithner Heads to China

The big news on all of the cable channels this morning is US Treasury Secretary Tim Geithner’s surprise trip to China. Secretary Geithner was in India meeting with Indian Finance Minister Pranab Mukherjee and apparently received an invitation to head on to China. Geithner will undoubtedly be talking about the renminbi (CNY), and China’s plans for their currency. As I wrote yesterday, Geithner postponed the April 15 deadline for the annual review of China’s trade policies, which was probably going to result in China being labeled a currency manipulator.

In announcing the postponement, Geithner said that a series of meetings over the next three months would be critical to bringing policy changes that lead to a stronger, more balanced global economy. So he took advantage of his trip to India to try and jump-start negotiations. But China has never shown a willingness to appear to fold to outside pressure regarding their economy, and China’s Foreign Ministry defended the country’s currency policy yesterday; saying it is not aimed at seeking a huge trade surplus.

Recent data point to a strengthening global recovery, which will allow the Chinese to resume a slow appreciation of the renminbi after pausing it for the past 20 months due to the global financial crisis. This is exactly what Geithner and the Obama administration would like to see. “I am confident that China will decide it’s in their interest to resume the move to a more flexible exchange rate that they began some years ago and suspended in the midst of the crisis,” Geithner told India’s NDTV yesterday.

Geithner’s boss, President Obama, will likely keep the pressure up next week when he will be hosting Chinese President Hu Jintao in Washington for a nuclear security summit. A move back to the slow and steady appreciation is what Chuck has been predicting all along, and seems to be the best path for everyone. It will allow the US administration to avoid labeling China a currency manipulator, and it will lead toward a wider acceptance of the Chinese renminbi.

China has been working to secure a broader role for their currency in international trade, and overnight announced they would start allowing the renminbi to trade against the Russian ruble, South Korean won and Malaysian ringgit. This is another step in their move toward global acceptance of the renminbi as a unit of trade. Last year China announced fixed exchange contracts with Brazil and a few other trading partners, bypassing the use of the US dollar for fairly large commodity contracts.

I think Treasury Secretary Geithner is taking a prudent approach in dealing with China. His annual review would certainly have labeled China a manipulator (after all they do peg their currency to the US dollar) and Senator Schumer and his colleagues would have sent us down a path which leads directly to a trade war. The last thing the global economy needs right now is a bunch of protectionist choking off what little growth we seem to be enjoying. China’s growing middle class is slowly pushing their economy toward a more balanced one, as Chinese consumption continues to grow. This will make it easier for the Chinese leaders to let their currency appreciate, and take on a more prominent role in global trade. But we had better be careful, for a more prominent Chinese currency would mean a lesser role for the US dollar.

The Chinese obviously know right where the dollar is heading long term, and see an opportunity to step in and grab a bit more global power. “There is no question whatsoever that the US dollar will go south in the long run,” Yu Yongding, former head of the People’s Bank of China, wrote in an Aussie paper yesterday morning. “Unless the US economy improves its trade balance, the dollar will fall. But the US cannot improve its trade balance unless the dollar falls.” The dollar will continue to fall, and that is exactly what the US administration wants to see. So much for the old strong dollar policy.

Trading in the currency markets was pretty subdued yesterday, with the dollar drifting higher versus most of the majors but staying in a pretty tight range. This morning we are seeing the euro (EUR) lose some ground versus the US dollar after a report showed that Europe’s economic recovery came to a halt in the fourth quarter. The EU report showed that GDP in the 16-member Euro-area remained unchanged in the fourth quarter after rising 0.4% in the previous quarter. An earlier report estimated growth would be 0.1% in the fourth quarter, but companies cut spending more than previously estimated causing the drop in GDP.

The euro has sold off a bit after the report as currency traders are now more confident that the ECB will keep the main refinancing rate at a record low tomorrow. But the news isn’t all bad for Europe, as some recent reports show that the economy is again showing signs of rebounding from its end-of-year slow down. Today’s report showed Euro-area exports rose 1.9% in the last quarter of 2009, and the recent sell off in the euro should help boost exports even further. Economic confidence improved in March and the region’s services and manufacturing growth accelerated to the fastest pace since August 2007.

It was a slow day on the US data front, with no reports until the afternoon release of the FOMC minutes. Federal Reserve policy makers saw an inflation slowdown across the US economy last month, encouraging them to keep interest rates at record lows for an ‘extended period’. A few of the officials warned of the risks of increasing borrowing costs too soon, another sign that rates will remain low in the US throughout 2010. KC Fed President Thomas Hoenig cast the lone dissenting vote in January and March, preferring to jettison the ‘extended period’ language and say instead that rates are likely to be low ‘for some time’. But no matter what the language, with unemployment remaining near double digits I don’t see the FOMC moving rates higher anytime in 2010. This is another reason the dollar will remain under pressure, as yield differentials push investors into some of the higher yielding currencies.

The Canadian dollar (CAD) has certainly been attracting a lot of investor attention recently, and traded through parity with the US dollar for the first time since July of 2008. The Canadian economy has benefited from rising demand for their commodity exports, including copper, gold, wheat, and oil. The country is also the world’s largest producer of uranium. Raw material exports to China and India have driven the Canadian economy, which has rebounded from the global slump more quickly than the Bank of Canada expected. Canada’s GDP probably grew at a 3.8% rate in the first quarter and will grow 3.1% in 2010, the fastest of all G7 nations. The BOC will likely become the first G7 country to raise rates as commodity price increases will put upward pressure on prices in our neighbor to the north.

Both Frank Trotter and Kristin Kuchem are in Vancouver this week, making presentations at an investment seminar. Frank took advantage of his plane ride to write another great piece for his new blog, and sent me a note last night to remind everyone about it: “Tuesday I headed out to the World MoneyShow in Vancouver. I have two talks to deliver and a lot of great folks to meet and see again. Before I even got to the airport I had my first lesson in economics. Catch up with me over the next couple days here.” His new blog really does stir up some great conversations; I would encourage you to check it out.

It will be another slow day on the data front here in the US, so the currency markets will probably be focused on an expected rate decision by the Bank of England and another by the Bank of Japan. The BOJ left rates unchanged today and kept its assessment of the world’s second largest economy unchanged. “We have confirmed that the economy is currently picking up steadily and on top of that, we are seeing some signs of future progress,” Governor Masaaki Shirakawa said at a news conference in Tokyo. Bank of America-Merrill Lynch cut its forecast for the yen (JPY), citing the prospect for continued yield differentials which will favor the selling of Japanese yen. The BOA believes the yen will trade at 92 yen per dollar by the end of June and fall to 97 yen by the end of the year.

The Bank of England is expected to keep their benchmark interest rates at record lows through the end of the year as the economic recovery remains ‘vulnerable’ according to the British Chambers of Commerce. Officials are also expected to extend their ‘quantitative easing’ program of bond purchases. Prime Minister Gordon Brown yesterday called an election for May 6, hoping to benefit from the end of the recession in the fourth quarter of 2009.

Technical indicators are pointing to a rally for the pound sterling (GBP). If the pound can move through technical resistance at $1.5382 it should rise to a two month high according to Forecast Pte. That level is on the neckline of a ‘double bottom’ which forms when a currency makes two consecutive troughs of about the same depth. So a move through will complete a traditional head and shoulders pattern and technical traders would expect the currency to move back to its recent highs. We are typically not technical traders here on the desk, but I wanted to pass this information along. My view, based on fundamentals, is that we will see a further decline for the pound in the coming weeks. The question of an election, combined with a very shaky recovery and further deficit problems look to keep selling pressure on the pound sterling.

The Australian dollar (AUD) was one of the best performers overnight, and continues its march toward parity with the US dollar. The Aussie continues to benefit from yield differentials, and the rate decision by the BOJ will only serve to move more Japanese investors toward the Aussie dollar. Yesterday’s rate increase by the RBA, and their strong talk of further increases helped push the Aussie dollar to a two-month high against the US dollar. The same factors that drove the Canadian dollar to parity with the US dollar are at work in Australia. The economy is benefiting from a sustained rally in raw metal prices, and their exports to China and the rest of Asia continue to grow. Improved risk sentiment also benefits the Aussie dollar, as carry traders borrow and sell the Japanese yen to invest into the higher yields found in Australia. This continues to be one of the best currency choices for investors looking for diversification away from the US dollar.

Chris Gaffney
for The Daily Reckoning