U.S. is Losing 'Currency War'

July 19, 2012 12:31 PM EDT
As we head deeper into earnings season in the U.S., an early trend shows that revenues for U.S. companies are missing expectations due to currency adjustments. For example, IBM reported a $1 billion dollar adjustment to revenue in the second quarter, which analyst say is related to a stronger U.S. dollar.

The value of the U.S. dollar index is near 2 year highs. The trend higher is a result, in part, of a weakening euro. Many emerging market currencies are also significantly lower compared to the U.S. dollar, with the Indian rupee recently posting a record low. Fear of a global economic slow down has forced flight to the U.S. dollar as the preferred safe-haven asset. Tempered efforts at quantitative easing efforts by the Fed are also adding to the dollar’s advance.

With the dollar clearly strengthening, and with the economy in the U.S. softening, many are wondering if the U.S. is losing the currency war.

The importance of currency valuation on manufacturing is obvious. Recently, Republican presidential hopeful Mr. Romney has pledged to label China as a "currency manipulator" on his first day in the White House. If this becomes policy, a Romney administration could lead the charge to impose punitive duties on imports from China to offset the advantages these goods enjoy due to the alleged undervalued currency – unless China's currency, the yuan, is appreciated.

Advocates of a weaker dollar say American manufacturing jobs are lost to China and other countries whose undervalued currencies grants its products unfair competitive advantage over America’s goods.

Recently China has allowed the yuan to appreciate but the United States still believes the currency remains undervalued and will press the issue with the Chinese, said Treasury Undersecretary Lael Brainard said on Wednesday.

"We have seen progress in terms of addressing the undervaluation of the currency but we believe the currency remains undervalued," she said in a speech in Washington.

The value of currencies is affected by a number of factors but one of the most notable is the supply on money, which is a function of monetary policy

In May of this year Fed Chairman Ben Bernanke made the following statement regarding the value of the U.S. dollar and inflation in China.

"If the Fed lowers interest rates and stimulates the U.S. economy, that means also that essentially monetary policy becomes easier in China as well. Those low interest rates may not be appropriate for China," Bernanke said. "China may experience inflation because it’s tied to U.S. monetary policy."

Based on this statement, it is fair to assume that a lack of QE in the U.S. is bearish for China inflation, which is positive for China. It also allows the U.S. dollar to appreciate, hurting U.S. competitiveness.

The bottom line is that some say by holding off on quantitative easing the U.S. may be benefiting China while undercutting growth in the U.S.

In other words, if there is a currency war - and maybe there is and maybe there isn’t - but if there is, the U.S. is probably losing.

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