Dollar falls against Asian currencies after China says it will end link
(New York Times)
Updated: 2005-07-25 15:18

The dollar dropped sharply yesterday against the Japanese yen and other Asian currencies and Treasury yields shot higher after China announced that it was revaluing its currency and ending its direct tie to the dollar.

But the dollar was off much less against the euro, and the stock market, while down for the day, did not slump significantly even after China's announcement and the bombings in London. Shares of Wal-Mart, which buys billions of dollars of goods from China, fell 1.2 percent.

But the market might have been ripe for a fall anyway; both the Standard & Poor's 500-stock index and the Nasdaq composite index reached four-year highs on Wednesday.

Hugh Johnson, chief investment officer at Johnson Illington Advisors, said the overall reaction in both the stock and bond markets was "subdued," which he took as a positive sign.

It is too early to know the China move's long-term impact on the dollar and the Treasury market, analysts said. Handicapping was hampered by the fact that the Chinese disclosed few details of how its new foreign exchange operations would work.

All that was said was that the Chinese currency, the yuan, which was pegged to the value of the dollar, would now be a managed currency whose value would be set in relation to a basket of currencies. The currencies were not identified, and it is not clear yet how much higher the Chinese will allow the yuan to move against the dollar.

"One thing I would emphasize is how little we know," said Steven Englander, chief foreign exchange strategist for the Americas at Barclay's Capital.

Mr. Englander said that if China continued the revaluation of its currency at a modest pace - say 4 percentage points more over the next 12 months - it should have minimal effect on the dollar's value against the euro. As for the yen, the impact should be larger, but he argued that there were still more important factors influencing the dollar against the yen, including the Japanese economy.

Lewis Alexander, chief economist at Citigroup, said the firm's forecast for a decline in the dollar was based partly "on our assumption that China would do something like this." But Mr. Alexander also said a weakening of the dollar would require a slowdown of growth in the United States and a pickup abroad.

The drop in the dollar yesterday reflects the view that the currencies of Japan and other Asian countries will rise if the Chinese continue to revalue their currency higher.

In addition, Japan is likely to be a little less resistant to a rise of the yen against the dollar because the revaluation of the Chinese yuan, if it continues, would make a yen increase against the dollar less damaging to Japan's competitive standing compared with China.

The dollar dropped 2.6 percent against the yen, to 110.08 yen, but just 0.7 percent against the euro, which was valued at $1.2189.

The Treasury market sold off because investors believe that the currency shift by China will mean the government will hold fewer dollars in their reserves and thus will buy fewer Treasury securities in the future.

China had to sell yuan and buy dollars to keep the yuan pegged to the value of the dollar. With the reinvestment of these dollars, China has become the second-largest holder of Treasury securities after Japan, with $243.5 billion, and also a big buyer of securities from government-sponsored agencies like Fannie Mae.

The yield on the Treasury's 10-year note rose to 4.27 percent, from 4.16 percent on Wednesday, while the price, which moves in the opposite direction, fell 29/32, to 9826/32.

Louis Crandall, chief economist at Wrightson ICAP, said the yuan revaluation "is more likely to be bad for Treasuries than good." But he said it was unclear what the ultimate effect would be.

Mr. Alexander of Citigroup argued that the Chinese could actually have to buy more dollars in the future to keep the yuan from rising in value further or faster than they want.

This would happen, he said, if the new Chinese currency regime actually encourages more investment from abroad. And this could happen if investors decide they want to invest in China before the price of the yuan rises further, making it more expensive.

As for whether the currency move will help reduce the United States trade deficit with China and its record deficit with the world, analysts said the revaluation would not accomplish that result on its own. The need to reduce these deficits has been one reason the Bush administration had been pressing China to decouple the yuan from the dollar.

But Mr. Alexander said the move was "significant in that it is the beginning of a process that will help to close global imbalances over the long run."

(courtesy of the New York Times)

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