By Evaldo Albuquerque, Editor, Exotic FX Alert
While the entire world is focused on the debt crisis in Europe, there’s another crisis quietly erupting here in the U.S. that could be just as dangerous.
It has the potential to tip the whole global economy back into recession.
We’ve seen it happen before, about 80 years ago.
After unemployment soared to 9% back in 1930, politicians were under a lot of pressure to create jobs. So the U.S. government implemented the Tariff act of 1930. This new act raised tariffs on imported goods to protect Americans’ jobs from foreign competitors.
The result? Seventeen countries responded with their own tariff plans. Suddenly, we had a trade war on our hands.
This trade war caused a collapse in global trade, and ended up deepening the global depression and increasing unemployment.
Now the U.S. Senate could make the same mistake their predecessors made during the Great Depression.
While this would be disastrous to the global economy, it would also provide some of the best currency trades in emerging market currencies next year. It all depends on what Congress does next…
The Bill that Would Guarantee a
This past Monday, the U.S. Senate voted to open debate on a bill that would impose tariffs on imports from countries with undervalued currencies, such as China.
In response, the Chinese government quickly warned this would lead to a trading war. As the Chinese Foreign Ministry said, this bill “will severely upset China-U.S. economic and trade relations.”
In other words, China is telling us that if we approve the bill, it will retaliate with protectionist measures.
This is a fight where everyone loses.
The European debt crisis is getting out of control, and the U.S. is heading into another recession. A trading war between the world’s two largest economies is the last thing the global economy needs right now.
But I wouldn’t be surprised if politicians approve the bill. After all, you can always count on them to do the wrong thing.
It’s all China’s Fault
The tensions between China and the U.S. can easily escalate in the months ahead, especially if the global economy continues to slow down.
With the U.S. struggling to grow, there’s increasing pressure for politicians here to “do something.”
Instead of implementing the right policies here at home to promote job creation, Washington prefers to blame China for our problems. It’s easier to say China is stealing “American jobs” by keeping its exports cheap.
Even Bernanke is now attacking China. This week, our Fed chief told Congress: “The Chinese currency policy is blocking what might be a more normal recovery process in the global economy. It is to some extent hurting the recovery.”
After failing to help the U.S. economy with its monetary policies, the Fed is now also blaming China for our problems. Typical.
Why Slow Growth Will Intensify this Conflict
Slow global growth will also give China a reason to put a break on the recent pace of yuan appreciation.
As you can see in the chart below, China has been letting the yuan strengthen against the dollar. It has risen more than 7% against the dollar since June of 2010.
Dollar Has Been Slowly Falling Against the Chinese Yuan
But during the 2008 crisis, China stopped that process by pegging the yuan to the dollar. China did this to promote growth through cheaper exports.
If demand for Chinese exports decreases because of a global slowdown, China will most likely moderate (or even stop) the pace of their currency appreciation, just like they did in 2009. That would give U.S. politicians another reason to go ahead with the bill.
Trading War Would Be Bad for Economy,
but Great for Traders
It’s too early to tell if politicians will be dumb enough to implement that bill, and ignite a trading war with China. But this event is definitely worth monitoring.
If the U.S. starts to impose tariffs on Chinese imported goods, China will retaliate. Things will escalate into a trading war, hurting the global economy, much like what happened in 1930.
While this would be bad news for economies, it would be good news for currency traders, especially those who focus on emerging market currencies.
A trading war would add to the long list of problems the global economy is facing. When any crisis like this hits the markets, currency traders tend to dump emerging market currencies and rush for the “safe haven” dollar.
Should this bill pass, watch for the dollar to rally against emerging market currencies. These smaller exotic currencies would get crushed in this type of trading environment.
For the sake of the global economy, I hope politicians here in the U.S. do the right thing and reject that bill. But if they approve it, I will be ready to profit from it by shorting emerging market currencies against the dollar.
Evaldo Albuquerque, Editor
Exotic FX Alert