The root cause of the very real threat that the world will experience a 'currency war' is the deep-seated perception of the Western Hemisphere that China is intervening in the foreign exchange market to ensure that the Chinese Renminbi remains relatively, and unfairly, weak. The argument goes that this is quite simply protectionism by another name, as it gives Chinese exporters a continuing advantage in world markets.
In response, the Chinese accuse the West, and specifically the US, of a) keeping interest rates so low that investors, disenchanted with the meagre returns they earn on deposit at home, send a flood of money to China seeking the speculative returns they would reap if or when the Chinese are forced to relent and to let their currency strengthen, and b) failing to remain competitive with China, as a result of American workers' bloated wages and profligate spending habits.
China's October 19th hike in interest rates was a surprise to the markets, but we don't believe it will actually do anything to reduce the chance of a 'currency war'. Although the hike might be seen by some as connected with the question of the value of the Yuan in that, by raising rates, the Chinese make the Yuan an even more desirable destination for 'hot money', so adding to the pressure trying to force the Yuan to appreciate, i.e. what the US wants, we see the matter entirely differently. If anything, the rise in rates is more likely an alternative to strengthening the Yuan, as both represent means to slow the overheated economy. In fact, the truth is probably that the two questions-rate hikes and currency policy-are, in this case, not well connected in the government's thinking. They just wanted to slow the property market, so they raised rates.
History teaches us that the more heated the public rhetoric becomes where China is concerned, the less likely she is to bow to demands, for fear of losing face and being seen to bow to external agendas, rather than acting in the best interests of the millions of Chinese workers now employed in manufacturing for export.
So, if the US is unsuccessful in its attempt to get China to strengthen its currency, then there is a very good chance that the American administration will plump for the next best thing, i.e. depreciation of the dollar against those currencies which can move freely, e.g. the Pound, the Euro, the Swiss Franc, the Australian and New Zealand dollars, the currencies of Scandinavia and Eastern European currencies. This list covers a vast swathe of America's trading partners and driving the dollar down against these currencies would be very politically popular in the US; especially welcome ahead of the upcoming mid-term House elections, in which the Democrats are facing a severe beating.
So, which currencies should a budding foreign exchange investor buy to achieve the maximum return? The answer must be those where the respective governments involved have a relatively relaxed attitude towards the appreciation of their currencies, the economy is strong, the financial system is healthy and the interest rate return achieved through holding the currency will be greatest.
This being the case, the Australian Dollar continues to stand out, with interest rates near 5%, an economy that could almost be said to be booming as a result of its commodity trade with China, an almost unscathed banking system, and a laisser-faire government attitude to the currency. What about the Euro and the Pound? Well, both have their potential Achilles Heels-for the Euro, a recurrence of this Spring's Peripheral Eurozone sovereign debt crisis and, for Sterling, a failure of the new coalition government to tackle the budget deficit, but I think you have a window to benefit from appreciation of these currencies, so long as you keep a weather eye on these issues.
A word of warning, however. This is not necessarily a 'one-way street'. The US dollar still has the capability to snap back in value in the event of a major unexpected geopolitical or economic crisis. In those times, the currency of the world's largest economy, which is still the premier reserve currency, will be seen as the ultimate safe-haven. So, be nimble!
An Honours Graduate from Oxford University, Nick Beecroft brings over 25 years of international trading experience within the financial industry, including senior Global Markets roles at Standard Chartered Bank, Deutsche Bank and Citibank. Nick was a member of the Bank of England's Foreign Exchange Joint Standing Committee. Nick also contributes to contributor to Saxo Bank's Tradingfloor website and relishes regular dialogue on the markets with clients at industry gatherings, such as awards dinners and conferences, at which he has in the past spoken.
In response, the Chinese accuse the West, and specifically the US, of a) keeping interest rates so low that investors, disenchanted with the meagre returns they earn on deposit at home, send a flood of money to China seeking the speculative returns they would reap if or when the Chinese are forced to relent and to let their currency strengthen, and b) failing to remain competitive with China, as a result of American workers' bloated wages and profligate spending habits.
China's October 19th hike in interest rates was a surprise to the markets, but we don't believe it will actually do anything to reduce the chance of a 'currency war'. Although the hike might be seen by some as connected with the question of the value of the Yuan in that, by raising rates, the Chinese make the Yuan an even more desirable destination for 'hot money', so adding to the pressure trying to force the Yuan to appreciate, i.e. what the US wants, we see the matter entirely differently. If anything, the rise in rates is more likely an alternative to strengthening the Yuan, as both represent means to slow the overheated economy. In fact, the truth is probably that the two questions-rate hikes and currency policy-are, in this case, not well connected in the government's thinking. They just wanted to slow the property market, so they raised rates.
History teaches us that the more heated the public rhetoric becomes where China is concerned, the less likely she is to bow to demands, for fear of losing face and being seen to bow to external agendas, rather than acting in the best interests of the millions of Chinese workers now employed in manufacturing for export.
So, if the US is unsuccessful in its attempt to get China to strengthen its currency, then there is a very good chance that the American administration will plump for the next best thing, i.e. depreciation of the dollar against those currencies which can move freely, e.g. the Pound, the Euro, the Swiss Franc, the Australian and New Zealand dollars, the currencies of Scandinavia and Eastern European currencies. This list covers a vast swathe of America's trading partners and driving the dollar down against these currencies would be very politically popular in the US; especially welcome ahead of the upcoming mid-term House elections, in which the Democrats are facing a severe beating.
So, which currencies should a budding foreign exchange investor buy to achieve the maximum return? The answer must be those where the respective governments involved have a relatively relaxed attitude towards the appreciation of their currencies, the economy is strong, the financial system is healthy and the interest rate return achieved through holding the currency will be greatest.
This being the case, the Australian Dollar continues to stand out, with interest rates near 5%, an economy that could almost be said to be booming as a result of its commodity trade with China, an almost unscathed banking system, and a laisser-faire government attitude to the currency. What about the Euro and the Pound? Well, both have their potential Achilles Heels-for the Euro, a recurrence of this Spring's Peripheral Eurozone sovereign debt crisis and, for Sterling, a failure of the new coalition government to tackle the budget deficit, but I think you have a window to benefit from appreciation of these currencies, so long as you keep a weather eye on these issues.
A word of warning, however. This is not necessarily a 'one-way street'. The US dollar still has the capability to snap back in value in the event of a major unexpected geopolitical or economic crisis. In those times, the currency of the world's largest economy, which is still the premier reserve currency, will be seen as the ultimate safe-haven. So, be nimble!
An Honours Graduate from Oxford University, Nick Beecroft brings over 25 years of international trading experience within the financial industry, including senior Global Markets roles at Standard Chartered Bank, Deutsche Bank and Citibank. Nick was a member of the Bank of England's Foreign Exchange Joint Standing Committee. Nick also contributes to contributor to Saxo Bank's Tradingfloor website and relishes regular dialogue on the markets with clients at industry gatherings, such as awards dinners and conferences, at which he has in the past spoken.
