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Currency tensions: Politics running ahead of policies

Stephen Roach, in a recent article in the New York Times highlighted the structural problem affecting the mother of exchange rate tensions: The fixed US$ – Yuan rate. The two biggest economies on the planet have structural disparities that need to be fixed, because they are not sustainable even within an horizon of two years:
Consumption: 70% of GDP in the USA, 35% in China.
Investment: 12% of GDP in the USA, 45% in China.
Exports: Trade deficit of US$ 600 bn, a surplus of US$ 180 bn in China.
Savings: Currently in the range of 3-5% of GDP in the USA, and 54 % in China.

Both countries need to undertake new policies to correct their part: The USA must save more and consume less. And the government must provide the stimulus to compensate for less consumption. Congress seems hesitant to back these policies. China must consume more and rely less on investment for economic growth. Yet to a large extent, the Chinese stimulus was mostly driven by investment. For a policy change in China, we will have to wait and glance into the next 5-year plan of 2011-2016. All in all, this is the gap in policy that needs to be closely watched in the future.

In the meantime politicians in both countries are pressured by the unemployment rate and the creation of employment. Mid-term elections are coming in the States and the likelihood of a meaningful additional stimulus looks slim. Meanwhile in China, the politicians’ eyeballs are fixed on forthcoming urban migration in the order of a hundred million people scheduled to take place in the next decade. This provides all the incentives to keep the exchange rate locked with the US$ to create the jobs on such a scale. They are understandably nervous to move their exchange rate to the extent demanded by other nations.

The result is that politics are running ahead of policies. The Americans are now playing the currency war: The US$ is dropping in the face of economic slowdown and weak resolve at the Fed. Asian countries with their ‘managed currency programs’, will manage. China will not move, and Europe is now left wondering what to do next.

The pressures are mounting for a compromise.

Posted in CFO & treasury, World economy.

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