As theUS brand new Treasury Secretary, Henry J. Paulson has done little to hide the fact that he practices a hands off approach with China.
In less than three months since the beginning of Paulsons tenure, the Chinese Yuan has already appreciated 1.4 percent in value against the US dollar, which is over half of the revaluation move that China made back in July of 2005. Yet the topic of the moment is not the Yuan but the Yen. With the Euro running towards its record highs against the Japanese Yen, the market is wondering whether Paulson will come under pressure by his European counterparts to criticizeJapan for allowing the Yen to fall so significantly in value.
However with the US dollar trapped within a 115.50 to 118.50 trading range against the Japanese Yen for most of summer, the movements in USD/JPY have been far less exciting compared to EUR/JPY. For the US, it is much easier to encourage changes from Japan than China, especially at the current moment when Japan needs to be extra cooperative with the US given that North Korea is stepping up on its plans to test nuclear weapons. Remember, currencies are as much economic instruments as they are political instruments. Yet if push comes to shove, Paulson will most likely opt for a more tacit and understated approach to make sure long term relationships between the US and its key trade partners remain strong, differentiating him from his previously unsuccessful predecessors.
Taking Cues from China
His approach with China is the perfect example. While rising the ranks of Goldman Sachs for the past 22 years to finally become its Chairman, Paulson made more than his fair share, or any politicians for that matter, of visits to the mainland, fostering relationships with former President of the Peoples Republic of China Jiang Zemin as well as meeting on occasion with the central banks Governor Zhou Xiaochuan. He has built upon these relationships as Treasury Secretary and has even taken active measures to understand the cultural differences between the two countries. He has also become the co-chair of the Asia Pacific Council of Nature Conservancy as well as retained founding chairmanship of the advisory board of the School of Economics and Management in TsinghuaUniversity in Beijing. Paulson is sure to have won many accolades or brownie points with the Chinese as he was able to convince Senators Graham and Schumer to postpone their 27.5 percent tariff bill on all imported goods which would have effectively promoted a protectionist trade war and worsened relationships beyond realistic repair. He has worked with both sides to bring them closer to the halfway line, promising Graham and Schumer, changes before the creation of a new bill early next year. Paulson is likely to use his buddy versus bully approach not only with China but also with Japan.
Is Europe Really Even That Worried?
So far, there has been no significant pressure from any side to strengthen the Yen against the Euro. Japan is naturally benefiting from the weaker Yen, but the pain in the Eurozone has yet to be felt. In fact, we just saw three consecutive months of rising exports from the Eurozone to Japan. Furthermore, the Eurozone only sends 2.8 percent of its exports to Japan, which is a tiny portion of its overall exporting activities. Back in September at the G7 meeting in Singapore, ECB President Trichet said the G7 agreed that the yen will reflect Japans exit from its zero rate policy and better growth. It seems that Japan may have reassured them that they will keep a close eye on the yen value and make sure it does not get out of hand. In the history of the Euro, the Japanese has never intervened to sell Euros against the Japanese Yen, only to buy it. So if they do, it will be a monumental event. Instead, they will probably opt for verbal intervention first before even considering physical intervention. We have already heard from the Japanese Ministry of Finances Watanabe who said Wednesday night that they are watching the movements in EUR/JPY to see if it becomes too volatile.
The Fate of EUR/JPY
With concerns among the central banking circles yet to heat up, EUR/JPY could head for a retest of the all time 150.73 high before we hear significant jaw boning once again. Paulson is much more focused on China at the moment, Japanese officials have their eyes on North Korea while the Europeans are watching inflation and the spill over from any possible slowdown in US growth the value of EUR/JPY seems to be only secondary.
