Forex Trading Strategies Blog

We have all read about China’s huge forex reserves vis a vis its highly undervalued currency and the US Dollar being overvalued in the face of the nation's huge current account deficit. According to traditional economics, for both these nations, the situation is unsustainable, and correction in their currency values is imminent.

A problem with economists is that they tend to rely too heavily on text book theories, and sometimes do not move with time to adapt these theories to a changed world. Most of the theories on the current account deficits and currency values were written when economies were still isolated and markets were not as yet so global.

Let’s study how investment and production work within the boundaries of an economy. The savings that the nation generates get ploughed back in the form of investment and it becomes a virtuous cycle. A healthy banking system facilitates this cycle, setting it onto a high growth path.

However, with the onset of globalization, things can begin to look different. China has accumulated a lot of savings in the form of forex reserves. China uses these reserves to buy US Government treasury instruments. This helps China keep the value of its currency low and at the same time keeps interest rates in the US low. Low interest rates fuel consumption growth.

US that is fulfilled to a great extent by China. Production in China is also driven by US MNCs that bring in technology and capital. In a way the US is acting as an efficient bank for the bi-economy set up. So the relationship can be termed sustainable and the two currencies can continue their anti-theory trends.

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