G7’s coordinated effort to weaken the Japanese yen was a surprise to most. Douglas Borthwick of Connecticut-based Faros Trading, however, anticipated this development because the surge in the yen took it beyond key levels against the Korean won and Chinese yuan.
To understand Borthwick’s reasoning, one must understand his underlying assumption of the ‘Grand Bargain.’
The ‘Grand Bargain’
Borthwick believes that a ‘Grand Bargain’ was struck between the United States, China, and other countries at the G20 Summit last November to allow for the gradual appreciation of the Chinese yuan and other Asian currencies against the US dollar.
By doing so, these countries would address the global imbalances that led to the financial crisis; it would slow the exports of undervalued-currency countries like China and South Korea to the United States, which acted as the world’s ‘consumer of last resort’ in the pre-financial crisis world.
Gradual and Synchronized Pace
The key to the whole agreement is the slow and gradual pace of appreciation for the yuan and other Asian currencies; Chinese Premier Wen Jiabao flatly rejected the possibility of a sudden appreciation, which he thinks will lead to massive bankruptcies and social unrest in his country.
A related point is that the pace of appreciation among various Asian exporters must be synchronized; if Japan appreciates much faster than China, for example, factories will leave Japan and move to China.
Therefore, when the yen’s surge last week took KRW/JPY below 7.00 and CNY/JPY below 12.00, the ‘Grand Bargain’ broke and G7 intervened to fix it.
Borthwick also claims that for the dollar to depreciate, it must depreciate against the euro, the second most traded currency in the world. So, whenever the European sovereign debt crisis flares up, the progress of the ‘Grand Bargain’ is halted.
When the European debt crisis resurfaced late last year, the US sent Treasury Undersecretary for International Affairs Lael Brainard to Madrid, Berlin and Paris to convince European leaders to support the euro currency and halt the crisis, said Borthwick.
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