Second leg down for the US dollar

Just over a week after announcing that the RMB-USD peg will again be lifted, the US dollar has taken another step down against the Chinese RMB. As of this morning, one USD bought 6.76 RMB. That is more than a 1% decline in 10 days.

How low can it go? We're not sure. China is wrestling against two very contradictory forces, the need to protect export-driven employment and the need to prevent inflation.

Months ago, I speculated that the Chinese government might resolve the problem with a one-time, massive double-digit revaluation. I still believe that this might have been the better recipe. Instead, the current scenario is sure to invite hot money speculation into the country, flooding the Chinese with even more unwanted US dollars.

Despite public comments to the contrary, the Chinese economy is facing serious challenges.

As the RMB appreciates, it will put even more pressure on the export-driven economy, reduce margins and potentially increase unemployment. The situation could have been even worse if China had not initiated its own massive stimulus plan and decreased the required reserve ratio for banks at the start of the global recession.

This, of course, brings us to the second side of the proverbial knife. Inflation. Loose lending practices in China over the past two years have resulted in mountains of bad loans, failed projects and a run-up in real estate prices. Aware of the problem, China has once again increased the reserve ratio for banks, tightened lending standards and put severe restrictions on borrowing to buy properties.

As we move forward into what could be an interesting late Summer/early Fall, it will be interesting to see how the confluence of these two actions impact Chinese businesses and, more importantly, the Chinese consumer.