3 Ways That China Could Flatten Your Forex Analysis:
by Heather Johnson
China is no longer the slumbering economic giant that it once was. Though this fiscal behemoth may still be a bit groggy, it has definitely made its way out of bed and has started feeling its way around the room. China adhered to a strict policy of political and economic isolationism for centuries, but now a nation that once had little affect on international markets is showing an inclination to start flexing its considerable economic muscles. One field in which China’s newfound liveliness could have the biggest impact is foreign exchange trading. If this stirring giant decides to do so, it will be able to bend the forex markets to its will. Be on the lookout for China to make any significant moves in these three areas, and if you see action in just one of them, throw out all of your charts and start your analysis over; forex traders will be living in an entirely different world.
1. Changing the energy game
The vast majority of all significant worldwide oil and coal purchases are conducted with the US Dollar as the currency of choice. Whether it’s Canada purchasing oil from Peru or Israel buying coal from Australia, these transactions almost always take place using Dollars. This virtual monopoly has helped keep the Dollar strong over the years, but this safety net could soon vanish.
China’s current per-capita energy consumption is roughly 7 percent of that of the United States, but this number is rising dramatically and will continue to do so for the foreseeable future. And though it may take China a long time to catch up to the US in its per capita energy gluttony, don’t forget that there are a lot more people living in China than there are in the States. As their energy needs have increased, the Chinese have recently become leading players in the global energy markets. If trends continue, everyone could soon be paying for their oil in Yuan rather than in Dollars, an unprecedented development that will wreak havoc on the forex markets.
2. Diversifying reserves in foreign currency
China’s forex reserves are undoubtedly its most important and influential asset in its economic relationship with the US. Until recently, the Yuan was pegged to the Dollar and, as often happens, a significant discrepancy began to develop between the value that the market would assign to the Yuan if it were allowed to float and the fixed value of the currency. As China’s economy took off, it began amassing forex reserves by removing foreign currency from circulation. This was done in order to suppress the value of the Yuan and maintain the peg to the Dollar. China accumulated immense forex reserves, which are currently estimated to be in the trillions of dollars.
Here’s where things start to get scary. The majority of China’s reserves are in the form of US Treasury securities, meaning that their forex reserves are primarily secured by assets that are denominated in Dollars. While this policy has annually helped bail the US government out of its expanding budget deficits, it has set up a situation that could be lethal for the Dollar. If China decides to diversify its investments by switching just a portion of its vast reserves from US assets to other foreign holdings, it could potentially send the Dollar into a sharp downward spiral, suddenly rewriting the rules for all forex markets.
3. Direct manipulation of currency markets
The most obvious and in some ways the most troubling way that China could affect global forex markets is using the Yuan, itself. As mentioned above, China has been keeping the value of the Yuan artificially low for years, not allowing it to appreciate as it would free of constraint. This has irked some US lawmakers and economic policy wonks, even as the cheapness of the Yuan has make many Americans much wealthier; a soft Yuan means greater purchasing power for the rest of the globe, especially as China solidifies its standing as the world’s factory.
Problems will quickly arise, however, if China were to abruptly revalue the Yuan by the 30% that many American experts are demanding. Not only would this have an immediate and drastic affect on all forex markets, but the repercussions in this arena would be extraordinary and long-lasting. Prices on nearly every product produced in China would skyrocket overnight and American purchasing power would plummet. This could quickly push the US economy deep into recession and deal a final deathblow to the Dollar.
By-line:
Heather Johnson is a freelance finance and economics writer, as well as a regular contributor for CurrencyTrading.net, a site for currency trading and forex trading information. Heather welcomes comments and freelancing job inquiries at her email address [email protected] .
Editor’s Note: I’m getting in some much needed family time this weekend, hence, I needed a little help here. Thanks to Heather for putting this together.
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