The China (forex) syndrome.

The 1979 movie The China Syndrome referred to the risk that a nuclear meltdown in the United States could theoretically go through to the other side of the world: China. The same concept applies to forex trading, describing how the Chinese economy can cause a meltdown in the world's currency

China's economic performance had led the globe in growth rates among major economies. The Asian Development Bank reports that "China's growth in 2004 will account for 15% of the expected expansion in the world economy, even though it only has about 4% of the global gross domestic product (GDP)." See "Sustainable growth?" (below).

The Chinese GDP and Money supply growth rate cannot be sustained without generating inflation problems and related investment bubbles. The Asian Development Bank's Outlook 2004 report from the end of April stated that the rapid growth of 2003 was due to slow this year. Most recently, the People's Bank of China, the Chinese equivalent of the Federal Reserve, began to tighten lending rules to reduce risks posed by its previous easy credit policies. The Chinese have achieved an unenviable record of 20%-40% rate of non-performing loans, depending on how that figure is counted.

The world is waiting to see whether China achieves a "hard" or "soft" landing. In either case, the status of the Chinese economy will affect many markets. The forex trader must follow the economic impact wave resulting from Chinese actions that will cascade across forex markets. Here are some currency pairs that will be best for playing the China card.

The Australian dollar is an excellent currency to consider for trading scenarios relating to China. China, as the world's largest consumer of copper, tin, zinc, platinum, steel and iron ore has looked to Australia as a major source for this supply.

After nearly two years of a strong uptrend, the AUD/USD reacted severely to realities and expectations of a Chinese slowdown. On April 29 after Reuters cited the Chinese premier asserting a strong policy to reduce the overheated Chinese economy, The AUD/USD fell nearly 1 U.S. cent. The reversal of fortune in the Australian dollar is not a surprise reaction to unexpected news. Rather, the fate of the Aussie and its major trend direction has been directly related to Chinese monetary decisions. The downtrend reversal of the Australian dollar is a textbook case where a technical move expresses a deep fundamental force. Trading the AUD/USD on the basis of just a chart analysis is at best foolish and ignores the huge importance of China as the factor behind the price movements.

The Japanese yen, as reflected in the USD/JPY currency pair, will increasingly reflect the influence of news from China in 2004. China is one of Japan's biggest trading partners, accounting for nearly 25% of its exports and 35% of its imports.

These former rivals are in an unprecedented era of interdependence. The potential of a Chinese slowdown can undermine confidence in the Japanese recovery, which has experienced improvement in its own fundamentals. Negative news from China will add turbulence to USD/JPY price movements.

Trading the yen in the face of Chinese uncertainty will be more challenging, even for the professionals. The USD/JPY trader at his desktop should be forewarned to gain a deeper respect for the Chinese fundamentals and for the inherent volatility of the yen.

But the key relationship, of course is between the United States and China. China today generates 10% of U.S. imports, which makes it the United States' fourth largest source of outside goods, after Canada (18%), Mexico (11%) and Japan (11%). China also reinvests U.S. dollar holdings into U.S. securities and, after Japan in February 2004 held more than $607 billion, China is the second largest holder of U.S. debt, amounting to more than $145 billion. What China does regarding its economic challenges will affect U.S. markets.

In any case, the shape of the forex market is evolving from a tri-polar world of the United States, Europe and Japan, to a world that also includes China. For the forex trader, the ancient Chinese curse that a person should live in interesting times has arrived and with it a new admonition to pay greater attention on using both fundamental and technical analysis in shaping trading strategies.

SUSTAINABLE GROWTH?
The key numbers describing China's economic development show why it is a
force in the world's currency markets.

Major Economic Indicators, People's Republic of China
Item                         2001  2002  2003  2004  2005

GDP growth                    7.3   8.0   9.1   8.3   8.2
Consumer price index          0.7  -0.8   1.2   3.0   2.7
Money supply (M2) growth     17.6  16.9  19.6  18.0  17.0
Merchandise export growth     6.8  22.4  34.6  15.0  15.0
Merchandise import growth     8.1  21.3  41.0  19.0  16.5
Current account balance/GDP   1.5   2.8   2.2   1.3   1.0

Source: National Bureau of Statistics; International Monetary Fund;
staff estimates.

Abe Cofnas is president of learn4x.com LLC. E-mail: learn4x@hotmail.com.