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News : Global Economy Last Updated: Feb 11, 2011 - 5:26 AM


Currency Wars: Real rate of China's currency against US dollar is now rising at annual rate of 10 to 12%
By Michael Hennigan, Founder and Editor of Finfacts
Feb 10, 2011 - 5:02 AM

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On Monday, February 07, 2011, US Treasury secretary, Tim Geithner met with Brazilian President Dilma Rousseff in Brasilia, Brazil. He was accompanied by Under secretary for International Affairs Lael Brainard and US Ambassador to Brazil Tom Shannon.  

Currency Wars: The real rate of China's currency  - - the renminbi/ yuan (yuan; Mandarin for unit; renminbi; Mandarin for people's currency) against the US dollar is now rising at an annual rate of 10 to 12%.

C. Fred Bergsten, the director of the Peterson Institute for International Economics, a Washington DC think-tank, who was a Treasury official during the Carter administration, said in a commentary published this week, that if the current tends continues, it would complete the needed correction of 20 to 30%, and official US reactions suggest that assurances that the adjustment will continue may have been received. He said the movement appears to derive from effective US pressure, increasing expressions of concern about the issue from other countries (especially a number of major emerging markets) and, most importantly, changes in economic conditions in China itself.

Last October Bergsten proposed the introduction of a new policy instrument: countervailing currency intervention. When China or Japan buy dollars to keep their currency substantially undervalued, the United States should sell an equivalent amount of dollars to push back. The IMF should authorize such intervention when necessary to discipline countries that are violating their obligations by engaging in deliberate undervaluation.

On Wednesday, the economist said that "the nominal exchange rate of the renminbi has now appreciated by about 3.7% against the dollar since China announced last June that it would let the rate start moving upward again. During this same period, Chinese inflation has accelerated and is running substantially above that of the United States (which is less than 2%)."

He added: "Different indexes produce different results and all of the official numbers probably underestimate the actual pace of upward price movements in that country. It is safe to say, however, that the real exchange rate of the renminbi has risen by at least 5% against the dollar over the past seven months, producing a real appreciation against the dollar at an annual rate of at least 10% and perhaps as much as 12%."

The term "currency war" was coined last September by Guido Mantega, Brazil's finance minister and in the same month, Finfacts reported on the devastating impact of Chinese shoe imports on the Brazilian industry.

The Brazilian government plans to expand anti-dumping measures  to several Asian countries claiming that they are using China as a front for exports to Brazil.

The new administration of President Dilma Rousseff is fighting back against a loss of competitiveness triggered by an appreciating real, which has risen 38% against the US dollar in just two years.

The trade surplus is expected to plunge to $8bn this year and $5bn in 2012 from $20bn in 2010 -  - its lowest in eight years.

In São Paulo on Monday this week, US treasury secretary, Tim Geithner, said: "Brazil is seeing a surge in capital inflows. This is happening for two reasons. First, investors around the world see Brazil growing at a faster pace and offering higher rates of return relative to other major economies. But these flows have been magnified by the policies of other emerging economies that are trying to sustain undervalued currencies, with tightly controlled exchange rate regimes. Brazil and other emerging economies with flexible exchange rates and open capital markets have born a disproportionate share of both the benefits and burdens of these capital flows.

Managing capital flows in such circumstances is not an easy task. The fact is it’s very hard to use monetary policy tools alone to curtail inflation without putting more upward pressure on the exchange rate. Countries facing an outsized burden of adjustment and overvalued flexible exchange rates may need to adopt carefully designed macro-prudential measures, as a complement to fiscal reforms.

But Brazil and other emerging markets cannot address these challenges by their own policy choices alone. They need - - just as we do - - the support from the policy choices of other major economies. As countries with large surpluses act to strengthen domestic demand in their economies, open their capital markets and allow their currencies to reflect fundamentals, we will see more balance in the flow of capital, less upward pressure on Brazil’s currency, and more robust growth in Brazil’s exports, especially manufacturing exports."

Lim Say Boon, chief investment officer at DBS Bank, believes demand for yuan denominated assets will increase. He tells CNBC's Martin Soong and Karen Tso that the Chinese currency is firmly on its way to being regarded as a credible store of value:

Nicholas Hastings says in an article in a Wall Street Journal blog, that in the past, as central banks have accumulated dollar reserves from their intervention to keep their currencies down, they have often diversified these holdings into the euro. In fact, diversification has often been a big force in determining the direction of major currencies.

Hastings adds: "With sovereign-debt concerns still hanging over the Eurozone, with the succession of the European Central Bank presidency now in doubt and with talk of Eurozone stagflation on the rise, the economic recovery in the US is starting to look more attractive and the dollar itself a better reserve option after all."

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