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U.S. Urges China to Appreciate the Currency; Bernanke Expects 3% Growth for 2011

Mon, Jan 17, 1:31 PM ET, by ForexTraders.com

Gold stabilized by the end of last week and is appreciating a little, but the main theme of the market remains the indecision that we typically observe in this part of the year. For the past few years, markets have been tending to rally towards the year end, and sometimes this momentum reverses in the ensuing period. This year seems to follow a similar pattern. As such, we believe that gold will remain at around the level that it presently is, barring a sharp appreciation of global equity prices.

Meawnwhile, just a week before the Chinese President`s crucial visit to Washington, Gary Locke, the Commerce Secretary of the U.S. was reported as speaking of a turning point in the U.S.-China relationship. "Last year, China became the second largest economy in the world. And the policies and practices that have shaped our relations over the past few decades will not suffice", he is reported as saying. This comes, of course, after yesterday`s comments by Tim Geithner that China must strengthen its currency. Other issues that relate to trademark and copyright theft, Korea, and and the trade surplus, will be some of the top issues in the presidential meeting this week.

Should we expect the Chinese to submit to American pressure? Our pessimism about any substantial improvement in the bilateral situation is well-known to our readers, but with inflation running so high at home, the Chinese will be more amenable to somewhat faster appreciation of the currency, and the announcement of such an agreement could be regarded as a kind of public relations achievement for the Chinese too. In other words, we suspect that if nothing significant would come out of the meeting, the likelihood is that not mch should be expected to happen for the first half of this year on the USDCNY issue. All these imply that this week`s Chinese visit will be a very important event for us to watch.

The reason for our pessimism is that the Chinese system is not the kind that the Americans are used to working with. The country is huge, with ubiquitous corruption and a highly immature, and complicated legal system greatly hardening the task of those who would like to see strong improvements in a short time. The same is the case with the Chinese, who, for example, threatened to degrade relations with Norway in response to the Nobel Prize awarded to the dissident Liu Xiaobo. Neither side understands the other very well, both are highly suspicious of their partners behind the smiles, and have a tendency to usually expect the first step from the opponent before making any moves themselves.

In other events, the Fed Chairman is preventing is interpretation of the recent rise in interest rates as a sign that the economy is doing better. He says that it is not an indication that the Fed`s bond buying program is failing. But isnt`t there a chance that it is both? Still, we would like to give him the benefit of the doubt and perhaps attribute the rate rise to the recent improvement in outlook, which is, one should grant, not at all insignificant. This doesn`t mean that the economy is doing any better, but it means that the market buys the idea that the Fed is capable of inflating asset prices by pumping money. Higher asset prices implies an illusion of higher net worth for individuals, which should bring higher consumption, and a stronger growth outlook. It is not clear, nonetheless, that the recent boost to the outlook will be last as long as some people seem to believe.

He expect a growth rate of 3-4% for 2011, and along with his team at the Fed, he is looking at ways to improve the flow of credit to smaller companies. The funny thing is that he is the one responsible for the reduction in credit volumes to smaller, innovative companies. If you were the loan officer, would you extend credit to the government backed behemoth, or the promising upstart from somewhere with only an innovative, but untested to back his claims and pledges. The answer is obvious. It is not for no reason that the Soviet Union stagnated and collapsed in the 80s, in spite of its great advances in technology, science, and international prestige and power. The cycle must move on, and in our universe, destruction is a necessary part of the creative process. Perhaps there was a way out of the 2007-2008 that could have averted the worst results of the crisis, but apparently the one that the Fed and the Bush adminsitration chose, in which all the failing firms were saved in the name of too "big to fail", was not the best possible decision.

These debates, of course, will go on. All that we know is that the buildup of imbalances will not go on forever, and further, that the longer the cycle of bubbles lasts, the more times it is restarted, the more destructive it will be when the edifice of cards finally comes down.


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