May 17, 2011Dollar Drop? You Ain't Seen Nothin' Yet if Yuan Jumps
Americans worried about a weaker dollar may want to get used to it.
Whatever Treasury Secretary Timothy Geithner may say about a strong dollar being in U.S. interests, the likelihood is that the currency will fall sharply in the next few years. And you don't have to go much further than the pressure Washington is putting on China to revalue the yuan to explain why.
If the yuan appreciates between an annual 5-7 percent against the dollar over the next five years, as some analysts and traders expect, then the dollar is likely to slide anywhere between 20 to 30 percent on trade weighted and other indexes based on baskets of currencies.
And that isn't just the direct impact of the yuan on those indexes but because a strengthening of the Chinese currency would have a knock-on impact on trade competitors and partners in Asia and other big emerging markets, who would be more comfortable with allowing their own currencies to rise.
Add to that a correlation that has built up between the yuan and the euro — which have sometimes moved in tandem in recent years — and the positive impact of China's economic growth on the Canadian and Australian dollars and it is difficult to see an argument for a "strong dollar".
"People have been talking about dollar weakness, but we haven't seen anything yet," said Douglas Borthwick, managing director of Faros Trading in Stamford, Connecticut. "We're going to see dollar weakness across the board. For one, we expect the euro to move to $1.50 soon and go even higher when the yuan is revalued."
While the dollar had one of its strongest weeks last week, pushing the euro to its lowest since late March on Monday, the strength is seen short-lived by many and the greenback has still lost about 6 percent against the euro this year.
More Problematic
Further substantial weakness in the dollar over the long run would have major implications for the U.S. and global economies.
It would make the costs of manufacturing in the U.S. much more competitive but raise the costs of imports, potentially squeezing retailers and consumers. It would make it cheaper for foreigners to visit the U.S. and buy American real estate while adding to costs for Americans going abroad.
This should all help improve the U.S. trade and current account deficits, though the government's budget deficit and debt problems would be more problematic. If the decline in the dollar was too rapid, inflation could climb while China and other nations might reduce their holdings of U.S. treasuries, which could all trigger higher U.S. interest rates and increase the U.S. debt bill.
In the past two weeks, financial markets buzzed with speculation China will further relax its grip on the yuan. The expectations increased after the U.S. Treasury said, based on comments from Chinese officials during high-level talks last week, that the world's second largest economy now sees further currency appreciation as part of its inflation-fighting strategy.
Beijing has already allowed the currency, which is also known as the renminbi, to strengthen gradually in recent weeks for a gain of 0.9 percent against the dollar in April alone and it has now risen about 5 percent since Beijing loosened a two-year peg to the dollar last June.
Indeed, since first being allowed to trade within a wider band in 2005, it has risen more than 27 percent against the dollar.
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