The Guest Blog

Farrell: With Allies Like These...

I find myself back at the airport officially heading out of the country.

Toronto is the destination and while a non US territory, it feels like home. Maybe because the Canadian national anthem is the best in the world (Oh Canada, Glorious and Free), or maybe it's because episodes of Law and Order- SVU has been filmed there. Either way it's a trip I enjoy and I'll follow with Montreal in a few weeks.

Being in a foreign land I think it's appropriate to think international thoughts.

Enough for now with the health care plan and the constant vote count (still no brass ring for the administration, but they are trying.) Senator Dodd's "bipartisan" financial reform bill will cause some degree of partisan uproar.

But it's the action of Israel and China that needs be addressed.

Eugene Hoshiko

Premier Wen Jiaboa is worrying publically about China experiencing a double dip in their economy.

He has the appropriate backup from academia worrying with him about the stimulus package- or the potential end to it- and the loan programs that have helped growth that can't go on forever.

Others are worried about China overheating and creating runaway inflation.

But all seem to be taking aim at the US for daring to disagree with Chinese policies. Despite the Peterson Institute for International Economics estimating the Chinese renminbi is 20-40% undervalued, Chinese officials insist on keeping their peg to the dollar. China is adding $30 billion a month on average to its current $2.4 trillion reserve hoard. Some $900 billion of that reserve base is in dollar denominated assets. China fears the deficits in the US will eventually lead to inflation which will effectively devalue the dollar. Mr. Wen has called for keeping the renminbi "basically stable" despite calls by the US to allow the currency to appreciate.

It looks to me the Chinese have introduced enough liquidity since consumer prices rose 2.7% over last year. Money supply has increased massively and, believe it or not, there are spot labor shortages which could well imply wage inflation. Interest rates have been raised a bit and will surely be raised again and soon. But the renmimbi should be allowed to appreciate, not to please Washington, but to make imports cheaper and encourage consumption. Cheaper imports would temper inflation.

The currency dispute is aggravating other issues between the two countries.

China is upset about US arms sales to Taiwan. President Obama's meeting with the Dalai Lama is another source of tension and China is now making no secret of its disdain of US financial/economic management. They are in no mood to be lectured about world economic affairs. But to cling to an overvalued currency is long term not in their interests.

Another potential point of friction comes this April when under the terms of the "Omnibus Trade and Competitiveness Act of 1988" the US has to decide whether to label China a currency manipulator. I believe they have to review such things twice a year and it will be hard to finesse this one with segments of Congress up in arms about the dispute. Both sides are accusing the other of trade protectionism and unless carefully handled this could get out of hand.

You expect antagonisms to some extent with "non allies" but you would hope the allies wouldn't pile on when the administration is embattled like it is.

It's hard to figure the Israeli motivation for embarrassing Vice President Biden during his recent visit. Announcing new settlements in contested areas while the VP was trying to push the peace process forward is a slap in the face. Could they not care what America thinks? Tom Friedman in his Sunday column in the NY Times said the Vice President should have closed his notebook and hopped back on Air Force II. His parting words should have been, says Friedman, "Friends don't let friends drive drunk. And right now you are driving drunk. You think you can embarrass your only true ally in the world.. with no consequences?" Well, maybe they do think that and if so, the administration better get itself done with the health care hassle and refocus on the zillion other agenda items on its plate. The US and Israel need to confront the prospect of a nuclear Iran and an isolated Israel could decide on solo and drastic action. If the US and Israel drift, Israel might not care how the US would react to a military strike against Iran.

Back on the ranch, the first day of a busy week of economic news didn't offer up any surprises. The severe weather held back industrial production in February but it still eked out a gain of .1%. And that's despite a fall of over 4% in auto production which was probably Toyota related. The NY State Empire Index fell a touch to 22.9 from 24.9, but both new orders and shipments hit new highs. The employment sub component also went back to pre recession highs. As good as all that sounds remember industrial manufacturing accounts for between 13-16% of GDP and by itself won't move the needle much.

Net foreign buying of US long term securities (the TIC flows) fell to $19 billion from $63 billion. This number bounces around and at $19 billion it is still enough to finance our current account deficit. But I don't want to see this become a downward trend.

Vincent Farrell, Jr. is chief investment officer at Soleil Securities Group and a regular contributor to CNBC.