Dollar to feed off global worries

Troubles in the Far East mean more investment in the traditional safe haven currency
THE WORLD'S currency markets are set for another tumultuous week, with the mighty greenback the biggest winner as investors flee economic trouble spots from China to Russia.

On Friday the dollar, traditionally the safe haven currency, rose to its highest level for two months as the markets remained unimpressed by new measures to revive the Japanese economy and the approaching spectre of a devaluation of the Chinese yuan.

"We'll see the dollar get to 150 yen next week," said Chris Melendez, senior currency trader at Sanwa Bank in Los Angeles. The dollar closed Friday at 146.1 yen and 1.63 against the pound.

Further west, there were sharp falls in Russian stocks and bonds on Friday as the crisis in Asia led investors to shun further developing markets, which threatens to put pressure on the German mark next week.

Germany is the biggest lender to Russia and its currency would be likely to suffer should markets there run into serious trouble. The winner would be the dollar, but the pound could also strengthen as investors seek a safe European currency.

But the biggest threat to international monetary stability is China; its two currencies are once again under full-scale assault, owing to failing confidence in the Japanese government of Prime Minister Keizo Obuchi, and by a scaling down of the official growth estimates for China.

The governor of the Peoples Bank of China, Dai Xianglong,said last week that he "doesn't rule out the possibility of a small adjustment" in the yuan.

Even Vietnam devalued the dong by 7 per cent on Thursday to make its exports more competitive in the region.

"I don't think the Chinese will actually devalue, because that will send the whole region into shock," said Melendez. "However, I do see both Japan and China letting their currencies gradually depreciate."

China still has reserves of about $140bn, which it could use to defend its currency from speculators. Even so, China's monetary problems are compounded by the two currencies. The mainland currency, the yuan, is still not fully convertible. There is an official exchange rate, but a black market is in full swing. Observers in Shanghai on Friday reported a black market price of 9.20 yuan to the dollar, which places it 10 per cent under the officially posted exchange rate of 8.28.

Whether or not it's official, the marketplace is devaluing the yuan on its own.

The Hong Kong dollar, on the other hand, is a real currency that is traded freely throughout the world. The catch is that Hong Kong has pegged its exchange rate to the US dollar at 7.80, under a currency board system that has been operational since 1983.

Under that arrangement, the Hong Kong government stands ready to exchange its own local currency for the US dollar reserves at the targeted exchange rate.

Owing to the fixed exchange rate, speculative attacks show up in movements in the Hong Kong dollar interest rates. Right now, they are soaring over US dollar rates. Three-month bank rates were quoted on Thursday at almost 600 basis points over US three-month rates.

One thing is for certain. If Peking ever devalues the yuan, it had better do the same simultaneously for the Hong Kong dollar. If they were to adjust the official rate on the yuan, but do nothing on the Hong Kong dollar, then there would be a run on the Hong Kong currency board that would effectively empty all the reserves in one day.

One proposal is that Hong Kong should declare that the US dollar has become legal tender.