China Raises Red Flag On Dollar

Market Scan
Update

Parmy Olson, 11.24.06, 3:08 PM ET


Adds closing prices, gold miners.

Americans may be spending their dollars with merry abandon as the Christmas shopping season begins this Black Friday, and that might be a good short-term strategy: the greenback slid on the foreign exchange markets after a Chinese central banker expressed fears about depreciation of the U.S. currency.

“The exchange rate of the U.S. dollar, which is the major reserve currency, is going lower, increasing the depreciation risk for East Asian reserve assets," wrote Wu Xiaoling, deputy governor of the People’s Bank of China, in an academic paper. Wu is ranked by Forbes as the 35th-most-powerful woman in the world.

As New York trading wound down, the euro cost $1.3096, up from a $1.2951 close in London on Thursday. American markets were shut on Thursday for the Thanksgiving holiday. The British pound rose to $1.9323 from $1.9156. The dollar also fell to 115.79 yen from 116.14 and to 1.2091 Swiss francs from 1.2234.

Underscoring the potential for U.S. inflation in a depreciating dollar, an ounce of gold cost $645.50, up from $630.80 on Thursday.

Gold miners followed the metal higher: Newmont Mining (nyse: NEM - news - people ) rose 1.5%, or 67 cents, to $45.55, while Goldcorp (nyse: GG - news - people ) jumped 3.0%, or 81 cents, to $28.19. South Africa's AngloGold (nyse: AU - news - people ) Ashanti surged 3.4%, or $1.54, to $46.65.

The stock market dropped, with the Dow Jones industrial average and Standard & Poor’s 500 each losing about 0.4%, in part reflecting worries that foreigners would avoid dollar-based assets. Yet Treasury bonds rose as some of that money found its way into the credit markets, making their yields even less attractive to foreign investors. The benchmark ten-year note saw its return decline to 4.54% from 4.57% as the price rose $1.87 for each $1,000 of face value. European government bonds also were higher.

Wu’s comments marked the second time this month that a Chinese central banker had made dollar-wary comments. On Nov. 9, the central bank governor, Zhou Xiaochuan, was quoted as saying that China has plans to diversify its assets into “many instruments,” presumably moving away from the dollar.

China has never revealed the exact composition of its foreign currency reserves, but market speculation suggests at least 70% is in dollars. With Chinese reserves having recently topped $1 trillion, a move away from the dollar could have significant implications.

For months China has been soaking up U.S. Treasury bonds, using dollars from its huge trade surplus with the United States. Wu noted that East Asian investors not only face a currency depreciation risk from holding dollar-denominated assets but also falling interest rates on long-term bonds. There is some perhaps unintentional irony in that comment because China’s seemingly insatiable appetite for Treasuries seems to be a major cause of the falling interest rates.

Another cause is an expected slowdown in U.S. economic growth. Earlier this week, the United States cut its forecast for 2007 economic growth to 2.9%, down from an earlier forecast of 3.1%. (See “ White House Cuts Growth Outlook”) The yuan, whose fluctuations are restricted by the Chinese government, hit a record on Friday. The dollar fell to 7.8526 yuan, the first time it traded below 7.86. The Chinese currency has appreciated by 3.3% against the greenback since Beijing allowed a limited float last year.

Standard & Poor's said in a research note that it expects the euro to reach $1.32 by the end of the year.

Shu-Ching Jean Chen in Hong Kong contributed to this article.

http://www.forbes.com/2006/11/24/dollar-china-closer-markets-currency-cx_po_1124markets06.html