It is no secret that it would be advantageous to China:
- If the RMB would be REvalued against US$ – considering the US export market is dead or dying.
- If the RMB would be DEvalued against the € – considering Europe “should” take over as export market from the USA.
There is only a problem with that plan.
It won’t work! It is simply impossible to get it both ways.
RMB EUR USD
If the USD/RMB relationship is getting smaller (in order to make imports cheaper!) AND the EUR/RMB is getting bigger simultaneously (so exports to Europe gets easier by undervaluing the RMB) then the EUR/USD is not determined as to direction!
What we are seeing is a wildly unstable relationship between USD/EUR:
Since autumn 2008 the relationship has swung between 0.8 and 0.7 several times.
Whether these swings are due to Greek sovereign debt crisis or American subsidies to farmers is immaterial – from a Chinese perspective!
If China intervenes and buys ECB sovereign bonds thus raisin the value of the EUR – helping exports – they will inevitably lower the value USD and help imports. Which is the intention; but:
The Chinese hold large amounts of both European and US sovereign bonds and there is always a CB ready to step in and buy sovereign bonds when they get cheap – and refinance with a higher coupon. As many of these sovereign bonds are of short maturity by dropping interest rates – the CB’s just wait them out and reissue with a lower coupon!
So whatever gains China might have from export/import benefits will – again inevitably – be counteracted by the valuation of their holdings of sovereign bonds.
Normally (or rather ideally) these variations – always to the detriment of the creditor – would be compensated by a higher overall interest rate on sovereign bonds. This is clearly not the case at the moment as coupon on short maturity bonds is so close to zero, that it is BELOW inflation rate!
Flight towards liquidity and quality:
- In uncertain times there is a general investor flight towards quality – generally assumed to be sovereign bonds – which depress the general sovereign bond interest level.
- Furthermore there is a rush towards liquidity – nobody wants to be saddled with 10 year bonds except at a price: Or put the other way round unstable exchange rates with their inherent risks increases the interest distance between short and long term papers. This also brings the short term interest rate down.
There is nothing mysterious in this: That is how the market works.
Notwithstanding the problems PIIGS countries cause the main contributor to instability will be the Eastern creditor nations swing from being net exporters to being net importers – thus spending their national savings.
This swing WILL come as neither the American nor the European investments are going to explode nor is their consumption going to increase violently: This means that Eastern export markets have a depressing future ahead. Nothing surprising here.
All Western political leaders talk about “kick starting” the economy – until – Ups – the need to reduce public deficit raises its ugly head: In fact that is the vicious circle of depression.
Now the Eastern economies cannot escape either, they cannot:
- Keep building pyramids or cathedrals in the desert, as the Italians call them, because these “investments” use imports – directly and indirectly – and do not have a positive return.
- Increase consumption as their agricultural sector is not large enough – total production wise – to furnish even the slightest increase in standard of living. It won’t help keeping food prices down artificially (and the farmer dirt poor) – it might raise productivity; but not total production. And you can’t sell industrial goods to poor farmers and unemployed workers.
There is no way out:
There will be a swing towards being net importer from at the present (past) net exporters.
This more or less takes us back to where we started:
The Eastern economies will experience both increasing demand for raw materials and increasing prices simultaneously on these raw materials – at the same time. Thus they will be forced to dig into national savings – further increasing the loss due to dropping valuation of the holdings of foreign sovereign bonds as they are brought into circulation.