China’s willingness to fund the US current account deficit in return for a market for its goods has been one of the defining economic relationships of our time but one analyst believes the monetary stand-off is approaching end game.
“The interaction between US monetary policy and Chinese currency policy as the defining force within the foreign exchange markets for the past decade,” Simon Derrick, the head of currency research at Bank of New York Mellon, wrote in a research note on Tuesday.
Without this crucial link within the global economy, Derrick believes the dollar would not have fallen so consistently over the last decade while commodities rose and export-led economies dominated global growth league tables.
A dramatic intensification of these forces took place over the past 11 months as the Federal Reserve went through another "extended period of highly accommodative monetary policy," he wrote.
“Last week saw a visibly nervous head of the Federal Reserve tell a press conference that monetary policy would remain at its current highly accommodative levels for an 'extended period' and that the best way of achieving a strong USD in the medium term was by encouraging economic growth in a low inflation environment,” Derrick added.
A change of tone from Beijing is in the air, according to Derrick who believes the Chinese will have to take action unless they want to keep lending the US three quarters of a trillion dollars a year.
“Recent weeks have seen senior Chinese academics talking of the need to allow the currency to appreciate at a faster pace, a discussion in at least one magazine about widening the range of assets that reserves can be invested in, the governor of the PBOC complaining about the pace of reserve accumulation and even a number of members of the State Administration of Foreign Exchange talking about the nations aim by roughly 2016 to have achieved capital account convertibility,” Derrick pointed out.
“Although we have no way of knowing exactly when the dénouement of this decade old battle will emerge, it does feel to us as if we have entered the end game,” he added.