Financial Watch

For most of last year, elected representatives concern for our large trade and current account balances put pressure on China to revalue their currency. China responded with a modest revaluation last summer, but continued its policy to intervening in the foreign exchange markets to keep the yuan from appreciating too much. President Bush is set to meet with China’s president later this month and this meeting have renewed calls for China to do more to open up its growing economy to U.S. firms.

Economists have speculated for the past year that disillusion with U.S. policy abroad could impact U.S. economic growth if foreigner investment dries up. Our substantial trade deficit requires foreigners to invest more than $2 billion each day. Of further concern is how our economy might suffer if nations with huge U.S. reserves diversify their assets into other currencies. The direst predictions call for a currency crisis on the scale of that suffered in Asia during the late 1990’s. Financial Watch does not believe this scenario is a real threat considering foreigners rely upon U.S. consumption to fuel their own economies.

Trade frictions, however, could impact economic performance in the United States. Iran is in the process of diversifying its large U.S. dollar currency reserves into other assets. Several other oil-producing nations have also discussed diversifying reserves out of the U.S. dollar into other currencies or using the assets to fund domestic projects. Oil-producing countries are not the only nations discussing ways to diversify their reserves. China recently passed Japan as the largest holder of U.S. debt. Its rapid accumulation of U.S. dollars has led some Chinese leaders to press for a diversification of their reserves.

Under normal circumstances reports of individual nations seeking to sell the U.S. dollar would not be cause for alarm. However, our nation presently relies upon small interest rates spread across bond maturities to fuel our growing economy. The fragile housing market could easily collapse if long-term interest rates move too high. However, there are some positives if countries sell off some of their dollar-denominated assets. It might put some pressure on the U.S. dollar to fall. If this occurs smoothly, it should help to slowly restore a more healthy trade balance without disrupting economic growth.