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BROKEN EURO TROUBLE FOR CHINA AND US

BORIS SCHLOSSBERG
DIRECTOR OF CURRENCY RESEARCH, GFT

WITH the yuan up nearly 15 per cent against the euro this year, there was some speculation in the market last week that the People’s Bank of China (PBOC) was a major buyer of the currency as Chinese monetary officials tried to slow the chaotic sell-off. A drop in euro-US dollar below the $1.2000 level would prove to be extremely damaging for Chinese exports to the Eurozone, which remains China’s number one market, and could therefore have serious consequences for Chinese GDP growth in the second half of the year.

The issue of Chinese involvement in the currency markets raises a greater question of central bank intervention to prevent further weakness. The Chinese, like the rest of the G4 monetary officials, loathe the idea of Eurozone fragmentation. A move towards a new multi-currency regime in the Eurozone would create massive exchange rate and pricing problems for an exporter like China by raising transaction costs.

The current weakness in the euro poses problems not only for the PBOC but for all the major central banks of the world. For the export-driven Japanese, the strengthening of the yen to below ¥90.00 for dollar-yen and ¥110.00 for euro-yen could snuff out their nascent economic recovery. For the ECB the rapid decline in the euro poses more of political rather than economic risk, as the currency loses its stature and the resulting chaos leads to a possible collapse of the European monetary union. For the Fed and the Americans, who have staked much of their recovery strategy on expanding US exports, the recent rise in the dollar threatens the profit margins of the multinational firms that make up the bulk of US GDP.

With the passage of the near-$1 trillion rescue fund, Eurozone officials thought that they had taken care of the euro problem by taking credit risk off the table. However, with speculative shorts still gunning for the currency, G4 central banks may be forced to resort to intervention in order to stabilise the unit. Traders should not underestimate the resolve of the central banks to take on the markets in this matter because no official in the G4 wants to see the euro fail.

Boris Schlossberg and Kathy Lien are directors of currency research at GFT. Read commentary at www.GFTUK.com/commentary or e-mail borisandkathy@gftuk.com.