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China Building Strength of the Yuan


Can the "redback" make it as one of the top currencies in the world?

Editor's Note: The following is a free edition of Jeff Cooper's Daily Market Report. For a 2-week trial FREE trial, click here.

I hear her heart beating, loud as thunder
Saw the stars crashing
China Girl (David Bowie)

Last week a subscriber asked me to comment on the Chinese market.

My feeling about the subject reminds me somewhat of Willie Sutton's response when asked why he robbed banks: "That's where the money is."

Asking me to comment on China is like asking an economist to analyze a potential time/price harmonic with Kaiser Soze pattern following a Rule of 4 Breakout. Well, you get the point. Other than my economics class in college and my stint at Drexel Burnham in Beverly Hills, I have no formal fundamental economic training--and frankly, that may have been a blessing. I am not carrying a lot of the preconceived baggage regarding the financial markets that many educations have shoved down the throats of those hungry to matriculate.

In all seriousness, there is a lot of magical thinking and a lot of statistical significance imbued in both the "science" of economics and the "art" of reading the technical picture of the financial markets--neither of which will yield a high degree of certainty. If you are looking for certainty in the fundamentals of economics or the technical's of the stock market, you won't find it either place. Prowling the bowels of economic theory will offer little clarity: put 10 economists in a room and you will get 11 opinions. Nor are charts the compass of certainty when it comes to the stock market: there are many ships at the bottom of the ocean and I am quite certain they all had chart rooms.

This is a game of probabilities, not certainties. Nothing always works. What we are looking for is an edge. Many edges, ideally. I won't make you do this again, promise, but read that again: this is a game of probabilities, not certainties. Nothing always works.

That is why the secret to stock market profits is two-fold: use a stop, and decide where that stop is beforeyou initiate a position. Trying to figure out how to get out of trouble after you've gotten into it doesn't work well. Oh, and from my experience, a third prong to success is that after identifying an edge (set-up) and getting stopped out, consider taking that set-up the second time around if it retriggers. The stock market likes to bait participants. The second mouse usually gets the cheese. And if stopped out the second time, consider taking a perfectly good set-up the third time if it triggers yet again. There is a reason why the cliché, 'the third time is a charm' is so well-worn.

None of this has anything to do with China. The recent eclipse that was the tightest in the last 100 years and the next 100 years cut a swath directly over the country and may have nothing to do with China either. But it is interesting in light of the cycles regarding the Federal Reverse offered in this space in past months and the challenge that some in Congress are giving to the Fed. This is interesting in view of the idea that the amount of greenbacks that we owe cannot be supported by demographics, i.e. we can't earn our way out of the debt leaving three choices: default, remodification, or monetization.

The symbiotic relationship between the U.S. and China seems to be reaching a point of critical mass. Last week a high level Chinese delegation came to Washington. After they left, the US dollar made a 10 month low late in the week and gold exploded. Did the Chinese ask for something they didn't get and in response is the US getting slapped in the face? Trying to decipher the delicate relationship is a job for Jake.

According to recent reports, China is rapidly accelerating efforts to internationalize its currency with a series of maneuvers that could see the Yuan become one of the top three monetary units in the world. Some analysts expect that by 2012 as much as $2 trillion worth of trade flows may be settled using the 'redback' as China shifts its commercial tentacles throughout the commodity producing world. The red octopus is holding hands with the emerging markets of Asia, South America and the Mid-East. Will it become a choke hold on the US? It is worth considering that with all their wealth versus the great wealth destruction in the West in the last year, the US is bogged down militarily while China is not.

Currently, Chinese dreams of a major role in international currency transactions are impeded by Chinese government policy which restricts the yuan from trading freely around the world and being fully convertible. But that could change quickly. China has already inked a series of agreements with Argentina, Malaysia and Indonesia to allow their central banks to acquire yuan for use in trade with China.

The radical shift in attitude may arise from a desire to protect China from what it may perceive as a 'dollar trap'. This problem emerges when a country, through its trade, amasses a huge surplus of dollars, which it is effectively forced to reinvest in dollar assets. This is why China is the US's largest creditor. It has as much to do with necessity as desirability. China's US dollar assets have in the past been vulnerable to the whims of Washington. But the greenback is losing some of its hue. Moreover, the specter of a US consumer without the same tools to spend wildly should be making China nervous about the export of goods/import of US Treasuries double helix.

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No positions in stocks mentioned.

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