Under a worst-case scenario, the European Union may to need to invoke emergency treaty powers to halt a contagion by issuing an EU guarantee for Greek debt, which “if not contained … could result in a ‘Lehman-style’ tsunami spreading across much of the EU.”
Of course, under such a scenario, there is only one safe haven — and that’s the U.S. dollar.
U.S. Treasury Secretary Timothy Geithner told the U.S. Senate Budget Committee he believed China would let the yuan, also known as the renminbi, appreciate against the greenback, a move President Barack Obama contends is essential to the U.S. economy by making U.S. exports more competitive and lowering China's massive trade surplus, despite Beijing's public refusal.
“I think it’s actually quite likely (China) will move … I think they recognize it's important to them, in their interest as well,” Geithner said.
“It's an important part of what we're trying to do generally to try to make sure that the world is growing," he said.
"And that requires a level playing field for American exporters generally and we're going to work very hard to encourage those changes.”
It didn’t take long before Chinese authorities responded.
Foreign Ministry spokesman Ma Zhaoxu said that the yuan/renminbi was at a reasonable level — and that China did not deliberately pursue a trade surplus with the United States.
“At the moment, looking at international balance of payments and forex market supply and demand, the level of yuan/renminbi is close to reasonable and balanced," Ma said.
"Accusations and pressure do not help to solve the problem."
Offshore one-year dollar/yuan nondeliverable forwards (NDFs) — a rough gauge of market sentiment — Thursday implied a 2.8 percent rise in yuan during the next 12 months.
The yuan's spot exchange rate, which is tightly controlled by the central bank (PBOC), remains practically flat.
That said, the just released HSBC PMI prices paid index for China showed input prices rising at their fastest pace since July 2008, suggesting the average increases in prices faced by Chinese manufacturers are now rising fast.
With both input and output pressures rising, we can expect 5% inflation by midyear, particularly if key food prices start to drift higher, although a 2008-style spike is unlikely unless energy prices were to soar again.
Headline CPI is already testing 2%, as the disinflationary impact of excess capacity starts to abate.
It is nothing more than being reasonable to consider China will be obliged to further tighten its policy, not at least because of rising inflation and inflation expectations, and that could — note that I’m not yet saying “will” — culminate in a substantial one-time yuan revaluation.
Whatever happens, investors will have to try to navigate a volatile environment rather than the smoothly trending markets we saw in the second half of last year.
For currencies investors there is only one currency to have for the moment and that’s the dollar.
To keep it simple, as far as I’m concerned, I’m long dollar.
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