This week President Obama returns from China after applying public pressure to China on several fronts. He again called for the Chinese government to allow its currency the yuan to appreciate. He also announced that the US military would be sending 2500 soldiers to Australia. Soon the Chinese yuan and it’s lack of appreciation could begin to attract interest in the United States.
Several weeks ago the US Senate passed The Currency Exchange Rate Oversight Reform Act, which would impose tariffs on goods imported from countries whom are thought to have undervalued currencies, i.e. China. The bill was never taken up in the House and has likely stalled indefinitely.
All of this comes at a time when the International Monetary Fund (IMF) is publicly floating the idea of adding the Chinese yuan to its basket of currencies that make up its Special Drawing Rights (SDRs). SDRs could be the last place that developed countries turn as they race other nations in devaluing their home currencies.
The US federal government has continually accused China of currency manipulation and called on the emerging superpower to let its currency, the yuan, appreciate in value against the US dollar. However as long as China is the principal financier of US debt, it is difficult for Congress and the President to make a strong case to the world regarding Chinese currency manipulation. China has a vested interest in maintaining some form of a peg of the yuan to the US dollar and thereby capping the yuan’s appreciation in the short term.
Some believe that China holds the upper hand in this struggle because they are the party that is making the decision to continue to purchase US treasury bonds and allow the US to maintain artificially low interest rates. It has become almost the mythical day in the future, the day when China does not show up for a US treasury auction and the great reset of long term interest rates will be forced on the Federal Reserve, the US and debtor nations as a whole. There is little doubt that such a day is in the near future, what is debated however is just how drastic the reset in long term bonds will be. A huge spike in US treasury rates would mean disaster on US soil.
“We are closely watching the changes to the yuan’s exchange rate … and will encourage the yuan’s flexibility in both directions,” said Chinese official Wen Jiabao in a meeting with Obama in Indonesia last week.
While many economists believe that the Fed holds the keys to the future of long term treasuries, it could instead be the Chinese. The Fed and it’s probable mortgage backed securities buying program may have weak impact on interest rates if the lending market is still largely frozen for the majority of potential borrowers.
The reason there has been liquidity in the market for the last three years is because of the Federal Reserve’s willingness to print US dollars, so many assume they will be the actor to raise interest rates by tightening, but the huge question is whether or not they will do it on their own terms.
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