US Worries About the Trade Politics of Japan and China

It's tough being the reserve currency. The US is stuck in the middle of a swarm of trade capital and currency swings that must pass our way, given that these countries help shine our appeal. It's only fair, right? But everything is artificial with fiat currencies as governments constantly try to stable their value to shift market interest. The two big players are China and Japan, as the US tries to create this master plan for growth. Here's the scoop.

First, the back story.

In June, China decided to break it's peg to the US Dollar. Possibly to break US pressure for a more "market valued" yuan that will allow our dollar to decline and add appeal in the trade market. The goal is to artificially control domestic data impacted by currency valuations. China did state that the yuan's appreciation will be gradual; so in the long run, this will lead to higher prices of Chinese goods. Given that most of the goods currently in the US come from China, the US expects this to cause some added inflation. Of course, if everything works out perfectly. This should also provide us with an advantage to boost production and exports, adding domestic jobs and a flow of foreign cash into struggling manufacturers. Perhaps China's greater purchasing power will steer them towards the US, creating a good relationship that will probably pull us out from economic misery. Yeah, right. The problem is that US companies will most likely shift their business to other Asian countries with low costs (Made in Taiwan, Vietnam, Korea..ring a bell?).

Even though China has since allowed its yuan to appreciate, they have found ways to stunt its growth. The largest banks in China are state owned, and most are busy buying up US assets and treasuries to keep the appreciation stable. Yet, they buy Japanese Yen to diversify their holdings. The US is sweating bullets. The Yuan hit a new high against the US dollar on Thursday, rising for 5 consecutive trading sessions. However, Treasury Secretary Geithner argues that the "pace of appreciation is too slow, too limited." A 1% gain in a week for the yuan is not enough; the US wants it to accelerate 20%, a more appropriate rate, sometime soon. China has decreased their holdings of US Dollars, but they're still not out of the game, with their sneaky manipulation. The plan was to create this shift away from US Treasuries so that investors will become more productive given the decreased expectation of return. All the while everyone stays quiet about Japan. Ah, yes, Japan.

China's neighbor guaranteed $300 billion in US bonds. This stabilized intervention is meant to decrease the value of the Yen, given Japan's heavy reliance on trade. The Bank of Japan can implement as much as 35 Trillion Yen of intervention capacity. It's not over. Japan wants to create liquidity, they foresee inflation, and want to reduce debt. The power of the Yen is extremely important for the Japanese economy. But, stabilized intervention isn't necessarily good for our plan in the US. The purchase of treasury is a gimmick that may last for a while. The weaker Yen also made the dollar appreciate, although not significantly much as all eyes remain on China. If anything, this raised our standards for the Chinese to push their yuan in response to global threats to the whole currency re-valuation plan.

The US doesn't want such a large injection to the Treasury pile. The Japanese intervention also helped to boost the value of Gold. The US is stuck - we want to follow the success of export driven countries like Canada and Australia who rely on the purchasing power of China. We look at the crisis in Europe and how Germany used the depreciation of the Euro as a way to boost exports and help fuel expansion to bring the region back on its foot. The hard truth is that we might have lost our opportunity, or was there one to begin with? The reserve currency doesn't have the advantage to prolong currency strategy to boost productivity. This, once again, brings us back to the domestic drawing board. A task that so many believe is nearly impossible to handle.

As for the FOREX market, expect the US dollar to advance for a few more days against the Yen. After that, fundamentals will return to play, and the dollar will continue its struggle.