China's trade deficit with the US rose to another record in August, fanning the brush fires that have broken out in the currency markets. Currency issues dominated talks at the annual meetings of the International Monetary Fund and World Bank last month, as China dug in its heels and rebuffed pressure to accelerate the appreciation of the renminbi. The issues are far from settled and will still be smoldering, if not flaring up, when the Group of 20 leaders meet at their summit in Seoul on November 11-12.
The US may be losing its competitive edge, but it is not because of the currency market. The dollar index, which measures the performance of the dollar against a basket of currencies, fell to its lowest level of the year in October. The renminbi rose by 20% against the dollar from 2006 to 2008, and it has begun rising again, hitting a record high against the greenback last month. Nevertheless, the US trade deficit with China is still climbing.
The US House of Representatives voted 348 to 79 on September 29 to approve the Currency Reform for Fair Trade Act, which authorizes the Commerce Department to impose duties on imports from countries with undervalued currencies. The legislation faces tougher going in the Senate, but it has support on both sides of the aisle. "China is merely pretending to take significant steps on its currency," says Senator Charles Schumer, a Democrat from New York. "This sucker's game is never going to stop unless we finally call their bluff."
The truth is that foreign exchange rates are only one factor that affects trade flows. The real threat is that China will do the bluff calling and sell its hoard of US treasuries. Americans are reluctant to admit that the greenback is losing its grip on its role as numeraire, the unquestioned currency benchmark for the world economy. It won't be until Chinese coins start showing up in their change that many will recognize the expanding role of the renminbi on the world stage, as economic power shifts toward the emerging markets.
The dollar is sinking as the Federal Reserve prepares another round of asset purchases that will add more liquidity to the financial system. To continue printing dollars, the US will need the full faith and credit of China.
Meanwhile, the foreign exchange market is thriving. Some $4 trillion changes hands daily in the world's largest market. The emergence of foreign exchange as an asset class means that every major bank now has a presence in FX prime brokerage. The industry is responding with the people and technology to keep up with the demand.