Monday, 21 April 2008

On Chinese Currency Speculation

Once again China Financial Markets are spot on.

This latest post gives a good potted history of currency areas and their ultimate demise.

Where I agree with Pettis is that the Chinese will be more than likely better off holding RMB than buying other currencies. Given the likely revaluation upwards it would appear hard to find a better investment.

Pettis' fears over the demise of the EURO are however overdone. The EURO is certainly here to stay. We do not see US states clambering to exit the $ zone do we and there is no doubt that capital and labour mobility are increasing in Europe (although there is some way to go to meet inter-states levels in the US).

RMB and the EURO [China Financial Markets]

First of all, I don’t think Chinese investors should buy any foreign currency product until the RMB issue has been resolved. With the expected appreciation of the RMB as high as it is, only extremely high-yielding, very risky foreign-currency-denominated assets can be expected to match the returns one can get by simply depositing RMB in a bank account. Why take the risk?

Second, I think the euro is overvalued relative to the dollar, and although we may see more dollar weakness in the short term, my own bet is that the euro will strengthen in the one- or two-year horizon as Europe’s trade deficit continues to swell. Lombard Street Research, a London-based research group and one of my favorites, expects the dollar’s fall to be more of a bungee jump, and they expect the rebound will occur once the markets see the European trade deficit as unsustainable and the euro’s position as precarious. I agree.

Finally, and this is really a much longer-term issue, I am still very skeptical about the survivability of the euro. It seems to me that the strains in the euro zone – especially in countries like Spain, where monetary policy is much too loose, and Italy, where sovereign debt levels are rapidly becoming unsustainable – will put serious pressure on the euro once we end the current liquidity cycle that we have experienced over the past 15-20 year.

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