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The yuan remains the source of friction

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currency_2(Sept. 14. 2009)        The yuan and trade tensions

I guess you could call it lucky coincidence, but just after we raised the issue of China’s management of the dollar-yuan parity in last Friday’s Thaler’s Corner, President Obama imposed a 35% trade tariff on tyres imported from the Middle Kingdom.

We have regularly addressed the subject of trade “frictions” because, while the world appears to have avoided certain mistakes made during the Great Depression during the current so-called Great Recession, particularly in terms of monetary policy, the world economy remains exposed to prolonged stagnation a long as the yuan continues to be manipulated.

 

The United States has been criticised for its huge imbalances, caused by over-consumption and low household savings, and an unprecedented trade deficit, structurally financed by foreign investors.

With American households struggling, come what may, to resolve the first two problems, the reduction in the trade deficit can come either by a sharp hike in exports or by a drastic reduction in imports.

The dollar’s decline against the currencies of its main trading partners is a sine qua non condition of this adjustment. While such a shift has already occurred against the euro and the yen (90.20 this morning!), it cannot decline vis-à-vis the currency of its main trading partner!

Just consider that the US trade deficit in July totalled $4bn with Japan, $8bn with the European Union, $7bn with OPEC countries and $20.5bn with China

No one should be surprised by the US decision to impose trade sanctions, especially since it is specifically allowed for in the agreement China signed to gain entry to the World Trade Organisation.

As for the threats of trade reprisals on US poultry and auto parts, the United States has little to fear from today’s announcement by China to appeal to the WTO, since Chinese officials no very good and well that they have more to lose in a protectionist war with their main client

No, we would be better advised to keep our eyes on the response of the European Union, because it has absorbed the full brunt of the dollar’s and yuan’s depreciation.

As much as the dollar’s decline is natural in a floating currency system, despite the hurt caused European exporters, the yuan depreciation is beginning to provoke some teeth-gritting, particularly, in the backdrop of an expected 12 point GDP advantage for China in 2009 (+8% vs -4%). 

The problem is not yet excruciating, with the Yuan falling “only” 17% against the euro since February, but given the ECB’s religious opposition to taking action to counter its currency abusive appreciation, unlike the Swiss, we can look forward to this sort of protectionist tendency on the European continent.

Or we can look forward a real deflationist bust on the eurozone, as already seen in Spain and Ireland

-    Credit Crunch in the West

In the meantime, the debt deflation process continues its merry progression, as indicated by the Morgan Stanley study, which reports that the scant availability of bank credit is penalising smaller companies that have no access to bond markets, with a contraction in net loans outstanding in July (-€25bn).

Check out these comments from the two bankers quoted in the piece (source FT):

Brian Robertson, group chief risk officer at HSBC:
"Those companies you'd like to lend to don't want credit and in many cases those that do, you don't want to lend to."

Another large European lender:
"Banks are eager to lend money to good companies. But many of them don't need it. We are not going to throw good money after bad on weak companies."

We see the same phenomenon with American credit cards. Borrowers, capable of doing so, are reducing their debt, whose real interest rates have become prohibitive, while the less credit-worthy borrowers are being shut out.

As such, French Finance Minister Christine Lagarde’s plan to seek a one-year extension for guaranteed bank loans when the current system expires in October in exchange for a plan to boost credit volumes by 3% to 4% stands a good chance of running smack into the current process.     

It is worth noting the marked 8% decline in steel prices since late August, according to a study conducted by World Steel Dynamics, given overinvestment by the Chinese (Thaler's Corner 17-08-09: The Chinese Minsky ladder: a broken rung).

Iron ore prices have also fallen 18% since July. 

-         Industrial production on the eurozone

Industrial production figures, which came out this morning for Europe: down 0.3% in July. They leave something to be desired, as you can see for yourself in the following graph. In view of all the above-mentioned points, they should come as no surprise.

Industrial production on eurozone: changes since highs of 2008.
This does not at all look like one of those famous green shoots

TH_914

Biases:

We remain favourable to fixed interest rate instruments, now with a bias more favourable to the 5-10 year range than to our 2-year champion.

We say the same thing for stock markets. We have considered it prudent to avoid participating in the recent rally, since the risk/profitability ratio does not look all that sexy.

Erwan Mahé

Asset allocation and option strategy



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