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I posted 2 news articles earlier because I think they are significant in describing the muscle that China is now looking to flex in the Asian region. Through becoming a significant trading partner it is now seeking to re-write old notions. For some time, Japan has followed a theory first enunciated by Yukichi Fukuzawa (1868-1912) Where Japan should seek to distance itself from Asian neighbors. At the Tokyo Consensus, a statement released at the end of the Beijing-Tokyo Forum suggested that given Japan’s trade with China now exceeds that with the US perhaps Japan should “return to Asia and keeping close to the US.”
This would see a significant change in US power in Asia. It is one more check in my view that whoever rules trade writes their own global ticket. Over the past decade, China has moved up the trade partner list in Asia, Latin America and Africa. In many parts of the world it has overtaken the US as the primary trade partner.
The primary trade partner gets to demand a number of things. (1) which currency is to be used as the medium of exchange, and (2) how votes should be made in international forums.
China has already signed significant FX swap agreements throughout Asia, and is now looking to expand these agreements throughout Africa and Latin America. These agreements cut out the need for the USD in international transactions. It is early days; but as China seeks to use its own currency for trading purposes, the USD will begin to lose some of its glitter. There was a time when GBP was the global currency, when the UK ‘Ruled the waves.’ This was later supplanted by the USD, as the US navy took over from the UK following WW2.
Watching trade is very important. Throughout history the largest trade partner has dictated terms internationally. The US is gradually giving up this title to China, as the Tokyo Consensus and the ASEAN meeting show.
This weekend moved from bad to worse, as German lawmakers indicated they were less enthralled with Greece, and the IMF looked to back away from further Greek participation. The Twitterverse was filled with commentary that Spain was likely to need a full bailout too, and Italian regions started to seek more help.
Interestingly the Italian regions are asking for help at exactly the same time that the Federal government is trimming their respective budgets. As austerity begins to trickle down from the Federal to the State level in Italy and Spain, the regions will posture in order to beg leniency. This leniency is not coming.
A quick look at the EU/US 2yr basis swap this week would lead one to believe that fear has yet to take hold in Europe, and markets continue to perform relatively well. The 3-Month 25 Delta R/R in EUR/USD also points to a lack of option positioning in the EUR/USD pair. Spot EUR/USD though is another matter, with new lows an almost daily occurrence. Interestingly the last time the 3-Month 25 Delta R/R in EUR/USD was at his level was in late 2009, after which it rallied a full 9 big figures in a month. I dont know what catalyst would see a similar move this time around, but it should be kept in mind.
From conversations I have had over the past few weeks it seems like renewed selling pressure in the EUR/USD has come from US-based funds who are looking to hedge exposures in Spain and Italy. It is a blunt hedge. Hedging your exposure to Spanish banks or cash-flows from Spanish institutions should Spain leave the EURO by selling the EUR/USD is a Texas-hedge, but the lack of other hedging aveues is amplifying market action.
For some time now I have been stating that a change in the ECB’s mandate is needed in order for them to take charge rather than waiting on the underfunded EFSF or ESM to come into operation. Moves in the peripheral 10-yrs of the magnitude we have been seeing may just push the ECB over the edge. The interesting thing about Europe is, the more things look terrible, the more inclined the ECB and the EU are to act.
The IMF has been a disappointment. At first it was under-prepared for the European Tsunami, and has wasted a good deal of time building up its personnel in the region. Its lack of real leadership and involvement has resulted in the market removing any respect the IMF may have earned over the past 68 years.
Through this ‘blog’ I will continue to comment on the markets. I understand the market’s desire for a heavy EUR/USD, but continue to see the trade as jumping from the frying pan into the fire. If you don’t like the EURO, then look to commodity currencies like AUD and CAD. The USD has its own set of issues, issues that are coming up fast.