(OroyFinanzas.com) – The gloves are off. Finance Secretary Snow has his hands on his hips and is telling the Chinese to revalue. In turn they have said, not whilst speculation is so rife. The Chinese are always at best, inscrutable, so whether they are about to revalue soon or not, we just don’t know. In the past they indicated it could take another decade, in recent times the indications are much shorter term, ‘when the speculation has abated’. Well in a currency market, such speculation does not abate until it sees results.

Make no mistake the Chinese will not shift from their present position unless it suits them and they have had tremendous benefits from a weak Yuan. This will continue until the results they see that will benefit them are real. Whether it is a speedier move of Taiwan back to China or whether it will have to wait until the Chinese banking system is more developed and stronger, we just have to wait and see.

One perspective that seems to be missed on this front is the very nature of China. Many in the West assume that China is moving quickly into the Capitalist world and will slot in with the way of doing things there. As though Capitalism of itself will overcome the inherent nature of the ex-communist system and another major world player will arrive on the scene, touching a forelock and taking its place alongside other new players. We believe China is and will write the rules to suit itself when it sees fit. We mentioned the archaic banking system, which when put next to a Western style banking system just won’t do the job. It works in China because it is subject to the government. In the West the banks have moved into a dominant position that rules all our lives. An interest rate move alters the economic climate almost overnight.

But the developed banking system is not the reflection of the advancing system of civilisation we have, it is a form of economic management that has evolved within the context of the Western economic cultural demands. Money is the cornerstone of Western civilisation with government an equal and often not dominant partner. Government in China dominates and the banking system, the very nature of credit and the economy, will have to obey it. We have seen this system work [even if not approved by us]. The government control of growth both locally and globally has brought a focus and vigour to China that has bulldozed it onto the global screen shoving aside the interests of those already in that picture. China will not touch a forelock to the U.S. unless there are distinct short-term advantages to it doing so. We have to factor in this side of China’s nature to understand what lies ahead. Western rules governing Capitalism cannot be applied to China! To ignore this will be to get the future hopelessly wrong!

The imposition of duties on textiles, etc, is a step already taken and the Chinese have stated their opposition to such moves. They will want to protect the global trade they have in place, but it will not be at the insistence of the States. We have a confrontational situation that has taken only three or so months to come to life. The next move is one of the structural shifts we have been warning of for some time now. The trouble is that it may well not turn out to the advantage of the States in the long run and possibly in the short run either, to see some revaluation of the Yuan. Certainly if the Financial Secretary of Honk Kong Mr Tang, is correct and China re-values the Yuan in terms of a basket of currencies, the $ could find itself on the back foot! Brace yourselves!

The Bush administration, reacting to a flood of Chinese clothing imports since January, announced on Friday that it would impose new quotas on cotton shirts, trousers and underwear from that country. The quotas will take effect when the administration notifies China of its decision and discussions are held about the size of the limits. China has already warned the United States and Europe that it will resist any attempt to limit its textile and apparel exports. The United States will limit any growth in Chinese imports of cotton shirts, trousers and underwear to 7.5% a year.

Several bills are being debated that would impose penalties on China for currency manipulation, violating intellectual property rights and following other forbidden practices like giving producers overly lenient loans and export tax rebates. Protectionism rules!

Price would present to the Chinese who remain strong potential buyers of gold in the future!

The Trade deficit drops, but so does Capital inflow!
Following on last months drop in the Trade deficit to $55 billion down from the figure we forecast of $62 Billion, Capital inflows for the month also slowed down to U.S.$ 45.7 Billion against the expected level of $65 to $70 billion and a realised figure of $92.5 billion in January and $84.5 billion for February. These fundamentals have not been fully factored in by the Traders on the foreign exchanges, as we saw in the performance of the $, which has shown so much strength of late.

These figures can display an imbalance in the very short term, but the overall story is that for a currency to remain stable, as much money as goes out must come in. If more goes out than comes in the currency must drop in value on the foreign exchanges. If more comes in than goes out, the currency must strengthen. Seems obvious doesn’t it, so can we expect such a continuation of the U.S. $’s strength if more goes out than comes in?

With the capital returning to be invested in Treasuries in the States, dropping three months in a row like this and now below the outflow, the sum total tells us that unless this picture changes soon, the $ has to resume its fall.

From another sources come the information that Central banks sold a net $14.4 billion of U.S. assets during the month, the largest sale since August 1998, the U.S. Treasury revealed, with the largest sale coming from the Central Bank of Norway.

Asian central banks, however, continued to accumulate reserves, with their stockpiles rising by about $30 billion over the month. These trends, to say the least are troublesome. The Asian Banks are still spending huge amounts on internal developments, so it is logical that they keep hold of the foreign currencies they have to pay their bills with. These reserves are not held for the long haul.

We do expect the drop in the deficit last month to be temporary, as the oil price even in the higher $40’s is draining funds from the States and Chinese goods, et al are being sucked into an apparently healthy U.S. economy. The question now surfacing is, is the U.S. economy as healthy as the market is assuming? Yes, the PPI figures [+0.3%] warn of higher inflation and prompting many to say this must lead to higher interest rates soon. But our line has always been that growth is the top priority for the Fed. With the Merrill Lynch survey of fund managers descibing a significant shift in their expectations of growth to the downside, followed by the Empire Index of manufacturing activity in New York collapsing [-0.2% against expected +0.2%], the bouyant picture painted by the retail sales figures recently and the imporvement in the payroll numbers questions the growth scene.

Julian Phillips

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