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Dollar traders brace for yuan appreciation

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1 Dollar traders brace for yuan appreciation on Thu Apr 22, 2010 11:03 am

littlekracker


Dollar traders brace for yuan appreciation
CHRIS ZAPPONE
April 22, 2010 - 12:13PM



The Australian dollar, which has been trading above 90 US cents for nearly two months, will face a fresh challenge if China revalues its currency against the greenback.

China has pegged its yuan at about 6.8 to the US dollar since mid-2008 to keep demand for its exports strong through the financial crisis. American economists and politicians claim the yuan is now being held about 40 per cent below value by Beijing.

If and when China revalues its currency, “it will be very negative for risk appetite in the market and the Australian dollar is somewhat correlated with risk,” said Travelex's head of client management Anthony Gray. “The Aussie will suffer as a result.”

The current yuan-greenback exchange rate makes American exports less competitive which in turn hampers jobs creation in the slowly recovering economy, where unemployment has climbed to 9.7 per cent since the financial crisis hit.

China, which holds about $US1.5 trillion ($1.7 trillion) in American debt - as part of total foreign reserves of $US2.5 trillion - has made no promises about if or when it will allow its currency to strengthen against the US dollar.

Indeed, China has argued its trade deficit in March - its first in six years - suggesting there's no need to alter the yuan exchange rate.

On the other hand, an artificially weak yuan is contributing to rising inflation in China and stoked assets bubbles, particularly in soaring real estate prices.

US report delayed

Nonetheless, a revaluation of the yuan remains a possibility and has been the subject of renewed discussions between Washington and Beijing.

Earlier this month, US Treasury Secretary Timothy Geithner delayed an official report, expected to be critical of Chinese exchange rates, opting instead to meet directly with Chinese officials in search of an agreement on the politically sensitive subject.

Although China has not changed its policy, analysts at Goldman Sachs and HSBC have interpreted a slight warming in the relationship between the two countries to mean China may eventually accommodate the US's desire for a stronger yuan.

Australia will be sensitive to any rebalancing of the exchange rate between China and the US, two of its biggest trade partners - but even then history may not much of a guide.

The Aussie dollar actually jumped 1.2 US cents to buy 76.49 US cents on the day of the last major adjustment to the yuan’s US-dollar peg on July 21, 2005.

The Aussie is currently buying 92.74 US cents.

What's changed?

If the Aussie dollar rose last time the yuan strengthened, the opposite may be true this time, economists says.

That's because China would only likely make such a move because its economy is growing too fast and authorities are looking for ways to cool demand. If China's growth rate falls, that will mean fewer orders for Australia’s iron ore and coal exports, with a negative impact for the Australian dollar, the economists say.

“As China’s fast-paced GDP growth has been driven by aggressive spending on infrastructure ... the Australian dollar should be quite responsive to the slowing of momentum required to bring Chinese GDP - at 11.9 per cent year on year growth in the first quarter - back down towards potential near 9.5 per cent,” said ANZ head of FX Tamara Henderson, in a report today.

Given the complex interplay of factors, though, other economists including NAB's currency strategist John Kyriakopoulos, say a stronger yuan may bolster the Aussie dollar over the longer term. That's because China’s economy in 2010 is more focused on local demand than five years ago.

“If China allows yuan appreciation to control inflation it will likely keep interest rates lower than otherwise, helping promote domestic demand,” he said.

“I still believe China doesn't want to slow its economy significantly.”

Waiting

To be sure, speculation has risen in recent years of a possible yuan revaluation, only to subside after Beijing stayed put.

The China Center for International Economic Exchanges, a local think tank, yesterday disputed the 40 per cent under-valued figure argued in the US and said appreciation wasn't needed.

However, analysts, such as US-based Peterson Institute for International Economics director Fred Bergsten, contend that a stronger yuan would be a plus for China by lowering the price of imports, helping to ease the inflation threat the economy faces amid such rapid growth.

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