Could Decline in China's Trade Mean Trouble for the Dollar?

03/12/2009 12:40 pm EST

Focus: FOREX

Boris Schlossberg

Managing Director of FX Strategy & Co-Founder of BKForex LLC, BK Asset Management

China’s trade surplus narrowed to $4.8 billion against expectations of $27.3 billion as imports fell 24.1% from a year earlier. This was the fourth straight month of declines in China’s trade balance, but today’s data was particularly shocking as it dropped to only one eighth of the amount of the previous month.

Chinese authorities have tried to combat the collapse in global demand by increasing domestic investment, including tripling railway spending and approving at least $35 billion in additional energy projects. However, with nearly 30% of all Chinese goods produced for the external market, exports remain a critical component of the country’s economy, and today’s massive decline in trade numbers augurs poorly for future growth.

More importantly, the sharp decline in export income is likely to translate into much weaker growth in foreign exchange reserves going forward. That in turn could greatly temper Chinese investment activities, just as the US is seeking record amounts of capital to finance its stimulus package. Today’s meeting between Treasury secretary Geithner and Chinese foreign minister Yang Heichi should be of interest to the currency markets, although it’s doubtful that either gentleman will offer any commentary beyond support for stimulus plans already announced.

The initial reaction to the disappointing Chinese trade news was a sharp selloff in commodity currencies and a rally in the dollar on safe-haven bid dynamics. However, the dollar safe haven trade could become suspect if persistent declines in export revenue begin to curtail China’s demand for US Treasury securities.  For now, the currency markets assume that US deficit financing will proceed without a problem this year, but today’s shocking decline in Chinese trade balance numbers suggest that the current consensus view may be much too sanguine.

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