[Calxy]

There is broad agreement that the financial crisis was caused by global credit growth and global imbalances. As the world deleverages and rebalances, the stock of debt shrinks, current account deficits correct abruptly and currencies move in line with this process. As we move to the post crisis episode, policymakers will seek to ensure that this adjustment happens smoothly but quickly enough to avoid planting the seeds of the next crisis. If we agree on the stylised fact of a world split in 3 large groups, Europe being in a fairly balanced external position, the US being in a deep deficit and Asia being in an equally large surplus; the adjustment will primarily involve the US and Asia, through a contraction of the current account deficit in the US and the reverse in Asia.

The delay in such processes will force the currency, which typically moves faster than real economic variables, to facilitate most of the adjustment. This is the central and driving force behind the weakness of the USD. In fact, the slower the real adjustment, the longer and the deeper the USD weakness will be. This also means that so long as the CNY remains pegged to the USD, USD weakness has to be even deeper against other currencies. Surplus currencies in particular, like the other Asian currencies, but also other currencies who should be relatively excluded from the adjustment process given they are in a relatively balanced external position such as the EUR, will be the collateral victims of an adjustment process impeded by the CNY peg.

Given the increasing focus of policymakers on the issue of rebalancing, the pressure on China will increase gradually until they are forced to move. Chinese authorities know very well that this process is inevitable.