Today's comment is by Jack Crooks, our Currency Director and Editor of Crooks on Currencies and Crooks Currency Options.
Dear A-Letter Reader,
If you happened to catch my ramblings in last Friday's A-Letter - You Have a Dog in this China-U.S. Fight - then you know the fuss I made over China's artificially weak currency and the impact U.S. government protectionism will have on China/U.S. relations.
I believe China is doing everything it can to keep its currency cheap - despite protests from U.S. politicians. In fact, the politicos in Congress are tired of waiting for the Bush Administration to act. These anxious politicians want to force them to act with new legislation that could alter our foreign exchange policy.
Under pressure from the U.S. and others, now the International Monetary Fund (IMF) is jumping into the fray. It could get very interesting as the players get serious about forcing China to act on its artificially weak currency.
Just in case you're not familiar with the IMF, a brief summary is in order. Here is their official mandate:
"The IMF is an international organization of 185 member countries. It was established to promote international monetary cooperation, exchange stability, and orderly exchange arrangements; to foster economic growth and high levels of employment; and to provide temporary financial assistance to countries to help ease balance of payments adjustment."
The IMF is now set to significantly hike up its exchange rate enforcement efforts. Their obvious goal is to force China to revalue its currency. Everyone involved is hoping this will eventually lead to rebalancing the huge U.S. trade deficit and the massive pool of excess reserves held in Asia.
Small Revision, But Still a Big Deal
The IMF executive board announced on June 15 they intend to avoid external instability. The methodology: IMF members now must treat exchange rate policies in a way that's acceptable to the international community. That means all the gripes and groans about a pathetic yen, or stagnant yuan, might finally be heard.
Addressing overvalued or undervalued currencies has become a touchy subject recently. The countries facing the harshest criticism are the ones that appear to be "manipulating" their currency, using it to boost a positive balance of trade.
It's tough to predict exactly what impact this will have on current exchange rate policies. It's even tougher to predict how long such changes will take to inundate global economies. Still, this event is important for both currency traders and regular investors. Here's why...
Never Has Uncertainty Felt So Good
I personally expect IMF intervention will simmer in traders' minds for a while before noticeable exchange rate shifts occur. Uncertainty will set in and a more volatile market environment will ensue. If you've been following my writings, you know exactly what volatility could mean to these markets.
Like I said a moment ago, volatility implies uncertainty in the minds of traders and investors. Uncertainty stems from the realization of risk.
For longer than I care to recall, risk has been out sick with the flu. It's nowhere to be found in the global markets. Not in any market, not anywhere. Consequently, the amount of money floating around the global financial systems seems to accumulate without end. Not until a true sense of risk finally reemerges will this flood of liquidity finally drain away.
I don't think the markets will be fully ready when the event occurs and risk really finds its groove. But regardless of whether the markets have any clue about what could happen, it's important to be prepared.
Only One Bad Trade Away from Another Crisis…
And Crisis = Opportunity
And it's not just me who's thinking about forex volatility. "We are only one bad currency trade away from another Asian financial crisis," says Nouriel Roubini, expert on the past Asian Financial Crisis.
Nouriel says the huge external forex reserve positions and managed currency systems of most of the Asian-block currencies, especially China, is dangerous to the global financial system.
I'm not sure how this movie ends, but it will be very interesting to watch it play out now that IMF has entered the picture. At the least, I expect a significant hike up exchange rate volatility during the second half of 2007. This should create some excellent trading opportunities for us.
JACK CROOKS, Currency Director
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