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Currency traders eye China for clues

Posted by smeddum on April 24, 2009


By William L. Watts,
Last update: 4:30 a.m. EDT April 24, 2009
LONDON (MarketWatch) – While foreign exchange is unlikely to be the subject of bold public pronouncements when the world’s most powerful finance ministers and central bankers meet Friday in Washington, China’s call for the replacement of the U.S. dollar as the world’s leading reserve currency is likely to be a hot topic behind closed doors, currency strategists said.
Namely, foreign-exchange traders will be looking for any clues to discussions with Chinese officials as policy makers around the world attempt to piece together the implications of remarks by China central bank governor Zhou Xiauchuan in March for the eventual replacement of the U.S. dollar as the world’s main currency with special drawing rights, the quasi-currency issued by the International Monetary fund.
The implication of such a policy would be a weaker dollar, as central banks move to diversify away from the world’s largest reserve currency. And that’s something that makes a number of policy makers, including officials from the 16-nation euro zone, nervous, analysts said.
The prospect of a substantially weaker dollar is unwelcome to policy makers in the euro zone, Japan or other countries worried about their own exports.
           Chart of C_JPY
The main thrust of China’s message is that it wants to diversify holdings of foreign exchange reserves in a way that more closely mimics the make-up of SDRs, said Simon Derrick, currency strategist at Bank of New York Mellon.
That means going from reserve holdings that stand at more than 60% dollars to around 44%. For the euro, holdings would rise to around 34% from 31%.
“You’ve got to read between the lines all the time,” said Stephen Gallo, head of market analysis at Schneider Foreign Exchange. Over the long run, euro-zone officials are going to be more worried about the prospect of a higher euro rather than a weaker euro, he said.
“All these policy makers are worried about a snap back (to lower levels) by the dollar” as the United States ramps up borrowing, said Gallo.
With export powerhouse Germany and the rest of the euro-zone laid low by a collapse in global demand, a rise in the euro would be unwelcome. Jitters over such changes may explain European Central Bank President Jean-Claude Trichet’s reiteration last weekend of his support for the U.S. government’s “strong dollar policy,” Derrick said.
Trichet’s remarks appeared to be aimed at reminding U.S. officials of the need to follow a fiscally prudent path, he said.
G7 finance ministers and central bankers meet Friday afternoon in Washington ahead of this weekend’s meetings of representatives of the International Monetary Fund. The bigger G20 group of policy makers, which includes China, is scheduled to meet later in the day. See related story.
The G7 includes the United States, Japan, Germany, Great Britain, France, Italy and Canada.
Reuters this week reported that an unidentified G7 source said Trichet and European Economic and Monetary Affairs Commissioner Joaquin Almunia would ask Chinese representatives about the SDR statements at the G20 meeting.
With that in mind, currency traders will be picking over remarks by Trichet, Almunia and other officials for clues, Derrick said.
           Chart of CUR_EURUSD
But news reports indicate G7 officials don’t expect the meeting to produce any major language changes when it comes to currency markets.
Euro-zone officials have little to complain about with the single currency trading near $1.30 versus the dollar, while the greenback has gained ground versus the Japanese yen since plunging below 90 yen last winter.
The British pound, which drew the ire of French and other euro-zone officials, remains fragile but is well off its winter lows.
The joint statement issued by the G7 at the February meeting of central bankers and finance ministers in Rome warned that “excess volatility and disorderly movements in exchange rates have adverse implications for economic and financial stability.” Policy makers pledged to watch markets closely and “cooperate as appropriate.” End of Story
William L. Watts is a reporter for MarketWatch in London.

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