Jamal Mecklai: Making China scream

MARKET MANIAC

Market players are notoriously knee-jerk in their thinking and the recent price action on the dollar (versus the euro), which, incidentally, has spilled over into the cocktail party circuit, is being ascribed to the renewed round of structural fumbling within the European Union, which was triggered by the French "non" to the European constitution back at the end of May.

This, together with fresh signs of weakness in some of the major European economies, will finally push the ECB""so the analysis goes""to cutting rates; with the Fed, at best on hold, at worst still tightening, this will continue to keep pressure on the euro.

[My belief, incidentally, is that the French "non" really signals a hiatus in the "inexorable logic of globalisation", but more on that another time.]

The yen, on the other hand, is hostage to the possibility that China may revalue, delink, change baskets, do something, sooner or later, which will give Japanese (and other Asian) exports a boost.

Hence, the yen, despite having weakened against the dollar, remains relatively strong""indeed, it has gained 7 per cent against the euro since mid-April.

Thus, the argument continues, the dollar isn't strong; it's just that the euro is weak. I mean, how can the dollar be strong""remember the twin deficits?

America has been living beyond its means for years and""again, sooner or later""the piper has to be paid, right? Now, a month or so ago, the US deficits had""surprisingly""slipped off the mental screen of the market.

They came back with a bang last week with the release of the most recent round of trade and capital inflow figures, which showed""yet again""that capital flows during April were not enough to cover the trade deficit.

With these arguments once again in the ascendancy, even though the symphonic growling of the bears that raged through most of the second half of last year has softened, the sound of bulls snorting is still nowhere to be heard.

There are, of course, people who expect the dollar to strengthen, but I haven't yet seen or heard any real dollar bulls scratching the dirt and snorting loudly""people who believe, and can back up their belief with arguments that the dollar will not just strengthen, but remain strong into the future.

Perhaps this is because, even at current levels""1.21 to the euro""the dollar is still weaker than its average value against the euro.

Since its launch in January 1999, the euro has moved in a range of 82 US cents to 1.37 dollars, giving a mean value of about 1.09. Thus, one argument goes, that the dollar could only be considered "strong" once it crosses this level.

And, almost by definition, it is only after this level that the dollar bulls will come out in droves.

Now, one thing I know is that the market's job is to make sure that the largest number of people are wrong. Thus, only when the number of dollar bulls far outweighs the number of dollar bears that the dollar can""possibly""start to weaken again.

This suggests that the market will continue to push the dollar higher, at least to 1.09 to the euro, and probably more. Of course, I rush to add, markets""and certainly liquid markets""are never one way, so the dollar's continued rise will certainly be punctuated with corrections, some of which may seem like a turnaround.

But, strengthen it will and I, for one, am here to be counted as a dollar bull this time around.

In addition to market nature, I have another argument. Over the past decade, China has evolved into a major global player. India is still aspiring, but China is there""clearly.

Now, when you are a big boy, you have to play by the basic rules. Now, don't get me wrong""all fudge the rules to their advantage as and when they can; you don't have to look much further than the EU's agricultural policy to recognise that.

But basic rules""in terms of apparently open market access, apparently open financial markets""are the minimum ticket to play. In this context, China's currency peg has become one of the most egregious problems in global markets.

Over the past two years, the market, acting on a need to balance the US twin deficits, kept pushing the dollar lower, in the reasonable expectation that the political outcry would bring the Chinese more properly into global markets.

No dice. China is doubtless working at ways to structure its internal markets to absorb the increase in volatility that such a change would bring, and it has been repeatedly made clear that China will move at its own pace, opinions, and expostulations, and threats of trade sanctions notwithstanding.

Well, while China has the political gumption and huge market to take on America or the EU or anyone else, not China not anybody can take on""and beat""the market.

Thus, I believe the market, having failed in its quest in one direction, will simply move in reverse. It will push the dollar higher and higher and higher, causing all "free" and relatively "free" currencies""including the rupee""to weaken, till the yuan peg becomes a liability and we hear China screaming in pain, resulting, of course, in a release of the peg.

It is hard to estimate what that level would be, although I suspect it may even be parity with the euro (or even stronger). Unless, of course, China, "on its own initiative, of course", recognises what is coming and aborts the process,""say, by the time the dollar rises just above 1.10 to the euro.