Yuan strengthening

Monkey Fister over at Blah 3 is pointing to an interesting article in Asia Times on a potential move by the Chinese central government and bank to loosen their export subsidizing currency control regime.

China will have to choose between the lesser of two evils, namely the protection of employment in its export-dominated industries or the safety net being created by investments in property and stocks by millions of its citizens. I believe it will choose to protect people's wealth more than lower-end manufacturing jobs; therefore a sharp revaluation of the Chinese currency, the yuan, is certain in the next few weeks.....

In turn, their holdings of US and European government bonds as part of foreign-exchange reserves would diminish, sending up bond yields globally. That is how the adjustment in China would likely set off broader stock-market declines globally as investors come to terms with both higher interest rates and lower Asian appetite for Group of Seven assets.

The second quoted paragraph is the standard oh-shit financial modeling scenario as the intervention of the Chinese and Japanese central banks as the leaders of a quasi-voluntary dollar denominated bond cartel has allowed the United States consumer to borrow massive amounts of cash at below market rates as these rates would be determined if buyers of dollar denominated debt were solely interested in generating high risk adjusted returns. Minzie Chinn at Econbrowser has a very interesting and geeky post that looks at some of the estimated deviation from expected values caused by the central bank intervention.

If the US dollar weakens as the Chinese central government reduces its purchase of US bonds and assets at currently low interest rates, US credit expansion will slow down, which means the US economy will also slow. Additionally, dollar denominated commodities such as oil and coffee will continue to get more expensive in dollar denominated terms even if their real value as measured against a trade weighted dollar excluded basket of currencies was to stablize or increase.

In the very long run, US exports, to China and other countries that allow their currencies to move in tandem with the yuan on the way up relative to the dollar, should increase, but the short run could be painful IF there is a significant increase in the short term relative value of the yuan.

Interesting times, interesting times....