A Currency Battle between Titans

Posted by Ken Norquay - Market Street Investment House

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And how should the typical Canadian investor react?

Sino–American Financial Olympics

People love athletic competition: there’s something exhilarating about winning.  We seem to get a high from Olympic victories.

But there is another international competition going on this year.  It’s a friendly competition between two great super powers, China and The United States.  It involves currency. Right now, the Yuan is pegged to the US Dollar: it’s a dead heat. But, unlike the Olympics, the goal in a currency race is to lose.  America wants to come in second.  America wants the Chinese Yuan to become a free-floating currency like the Canadian Dollar.  Their feeling is that, if allowed to float freely in the international currency arena, the Chinese Yuan would float upwards.  That opinion is shared by most currency analysts.  It’s as if the Chinese monetary athletes are taking performance-inhibiting drugs to keep the level of the Yuan low.  If the Yuan were allowed to rise against US Dollar, Chinese goods would become more expensive for American consumers, and American goods would become cheaper for Chinese purchasers.  A higher Yuan would favour America: the Americans want their currency to finish second.  In the international currency Olympics, the winners or losers are the average working people of China and America.

US President Obama has alluded to this problem in some of his recent speeches.  He is renewing his pressure on the Chinese to allow the Yuan to appreciate.  And if the Chinese do not cooperate, America’s veiled threat is protectionist trade regulations.  America could erect artificial barriers to Chinese imports into the USA.

But there’s another way to look at this race.  Is America really talking about devaluing her own currency?  That’s how it looks to the Chinese.

Right now China holds about 10% of America’s public debt; about $790 billion.  Some analysts estimate that China owns approximately double that if they include non- Federal government securities.  If these estimates are accurate, and the US Dollar was devalued by 10% vs. the Yuan, the Chinese would lose about $158 billion.  Ouch!

And right now our American cousins are running massive government deficits – their country is going even further into debt.  In order to finance that debt, they borrow.  They sell treasury bonds and bills.  And, so far, the Chinese have been willing buyers.

And now the Americans are rocking the boat so their consumers will lose [Americans would pay more for cheap Chinese imports.] and their workers will win [American exports would become cheaper for Chinese buyers.]. They talk about a more level playing field.  They want the Yuan to win and the US Dollar to be devalued.

And how should the typical Canadian investor react to the Sino-American Currency Olympics?

As usual, our advice is to be over-cautious.  An unnamed Chinese philosopher is credited uttering the curse: “May you live in interesting times.”  “Interesting times” means challenging, disruptive times.  You can see that his curse has come true: we do live in financially interesting times.  In the past ten years, the stock market has dropped in half twice.  We’ve had an international banking crisis.  The prices of oil and gold have sky-rocketed.  American house prices have dropped sharply. We’ve had two recessions.  The world’s biggest manufacturer, bank, brokerage firm, mortgage company and insurance company all had to be bailed out by the American government. People have had to re-think their retirement plans.  In the same way that the 1980s and 1990s were times of economic growth and stability, the 2000s have been times of instability and economic chaos.  And now the Americans and Chinese are squaring off for a currency contest.  These seem like good times to be over-cautious.

If financial instability increases this spring, it would be a good time to sell your higher risk investments [stocks, investment real estate] and purchase less risky securities. [Bonds, treasury bills]  And how can we tell if instability increases?  The stock market will drop.  A stock market drop of 13% or more from last week’s market highs could indicate that the current 54 week rally has reversed.  The risk is that the decline that began in 2007/2008 could begin again. In the financial Olympics, it’s sometimes best to not enter the race rather than lose.

Ken Norquay, CMT.
Financial Philosopher
Market Street Investment House

My book, Beyond the Bull, can be purchased on these sites: