The world may have taken a step back from that dangerous historical tendency. China announced it will allow a small rise in its currency, the renminbi yuan, against the dollar. It also said it is making a politically big move in the way it manages the yuan in the future -- pegging against a basket of world currencies rather than just against the greenback.

End no, start yes

Qualified kudos go out to the patient leadership of Treasury Secretary John Snow and such key aides as Tim Adams. (Now is the time for Senate Democrats, therefore, to remove the block on eighteen -- 18! -- senior Treasury appointments.)

But similar praise is owed to Sen. Chuck Schumer, D-N.Y., whose tariff bill helped provide a stick to the Bush administration's carrot.

Above all, two cheers or more are due to the Chinese authorities themselves. Today's policy change is not nearly enough to redress the dangerous imbalances in trade flows, debt prices, and exchange rates that exist in the world economy. China, however, did not create these forces all by itself.

What does it all mean for investors? Before getting to that, it's important to remember that 2 percent revaluation of the yuan is not "peace in our time," or the end of monetary dislocation in the global economy. But it may be the beginning of a process that will lead us there. Two factors are critical:

1. Global money

Much of America's chronic difficulties with trade and budget deficits reside in what Rogers notes is "the reserve currency system." Given this special role for the dollar, U.S. Treasury securities and dollars account for most of the world's trade, commodity pricing, and official reserves. Other countries have currencies; the United States has the world's money.

In effect, the United States has a special checking account -- we write checks that, rather than being cashed, go into circulation as if they were money itself.

The result is an overhang of dollars around the world, people taking debt and pieces of paper in exchange for real goods and services. The United States runs a trade deficit, yet the dollar never collapses to an equilibrium level because we never have to fully or automatically balance our account.

The economists who best understand this system and its implications are (full disclosure: my former business partners) Lewis Lehrman and John Mueller of LBMC, disciples of the late great French economist, Jacques Rueff.

Even a 20 percent or 30 percent rise in the yuan (not likely for years) would not cure the problem, i.e., would not bring the U.S. trade deficit up to balance or surplus. The Rueffian answer, as Lehrman notes, would be a global conference of the major players -- the United States, the European Union, Japan, China, India, and perhaps South Korea and one of the Arab states -- to discuss all in one place the inter-related monetary, trade, and other economic imbalances.

Short of this, the world will remain perilously close to a trade war, or monetary catastrophe or debt collapse, or all three. One country, even China, adjusting its exchange rate, will not alter the fundamental factors that drive towards U.S. trade deficits today. This is especially true given a second fundamental dynamic.

Global demography

The world's population is about to undergo the most seismic shift since the Black Plague, with the possible exception of World War II. In China, India, Europe, Japan, and the United States -- about half the world's population, and more than 80 percent of its industrial production -- we will, in the next 30 years, shift from a world of 5 or so workers per retiree, to 2-3 workers per retiree.

It is this, along with historical fears of the 1930s deflation that devastated China (not to mention the West), that is driving Chinese authorities to strive for a full-employment monetary policy in the world.

It is always better, of course, for the monetary authorities to avoid error in either direction, whether inflation or deflation. But given the world's demographic situation, a premium must be placed on achieving rapid employment, wage, and production gains.

The one exception to this rule is the exception that proves it. In Arabia, South Asia and the Muslim world, populations are expanding. Many of these young men and women, however, do not have gainful employment. They receive welfare checks that trickle down from their country's oil riches, and attend hate-mongering speeches in mosques much of the day.

Those Muslims, age 10 to 25, must be brought into the work force and the marriage pool. They are, in a sense, the youth bubble that could help fix the West's and China's age bubble. If they are not, then as the world has learned in recent years, well, they have other options.

If anything, in gearing its monetary policy toward full employment, China has been doing the world a service, whether intentional or not. If Beijing dramatically changed its exchange rate -- except in concert with the U.S. and others gearing the whole monetary system towards full employment -- the result would be bad for all concerned.

Bottom line

The fundamental implications over 6-18 months from this move -- and the further adjustments it implies -- are as follows.

Chinese Equities: China has not wholly removed the pressures for a tariff bill, but has taken a first step toward doing so. And the first step, given China's prudent concerns about domestic employment, is the most difficult. "Bottom Line" was short Chinese equities most of 2002-2005, and our investors began covering in early June. Now is the time to go long.

There will be much volatility, but Chinese equities should be a solid double over the next three years.

The Dollar: One reason for the dollar's rise in recent months, as noted here repeatedly, has been its link to the yuan. The only way for countries like Japan and Europe to devalue against the yuan has been to devalue against the dollar. Today's action removes one powerful factor in the dollar's rally.

But it only removes one. U.S. interest rates are how higher than Eurorates, and rising. The U.S. economy is surging; Japan is flat, Europe stagnant. Rising oil prices, likely to continue into 2006, hamper the U.S., but they savage the Japanese. Europe is in a political free-fall that may be ameliorated by German elections this fall, but which will fester on in France, and now, potentially, Britain. This is a good time to rebuild short positions on the yen, Euro, and sterling.

The Region: Most of China's neighbors and trading partners, including Indonesia, Thailand, and Malaysia, should benefit. These are a buy. The Philippines will benefit from the yuan per se as well, but remains a short given political turmoil.

U.S. interest rates: "Bottom Line" advised shorting the U.S. 10-year with yields in the 3.85 range, and attentive readers have profited from that advice. At more than 4.25 today, the 10-year is about two thirds of the way to what should be a yield of perhaps 4.5 at Christmas time.

This is a good time to take profits, reduce the position a little bit. But the Treasury complex still should have more to go to the downside in the coming six months.

Housing Stocks: Home-builders that have been engaged in aggressive lending -- 0 percent down; teaser interest rates; sales focused in California, Nevada, Florida -- are a screaming short for a number of fundamental reasons. (Among these are KB Homes and Standard Pacific.) The yuan move, as seen in today's impact on the 10-year Treasury, simply adds fuel to the fire.

In short, long Chinese equities, still long the dollar, getting short the U.S. housing sector -- with a close eye on events, which, as ever in China, are fluid.

Gregory Fossedal, [email protected], is an adviser to international investors on global markets and ideo-political risk and a senior fellow at the Alexis de Tocqueville Institution. His clients may hold long and short positions in many of the investment securities and opportunities mentioned in his reports. Investors should perform their own due diligence and consult their own professional adviser before buying or selling any securities. Fossedal's opinions are entirely his own, and are not necessarily those of his clients, AdTI, or United Press International. Furthermore, they are subject to change without notice.

All rights reserved. � 2005 United Press International. Sections of the information displayed on this page (dispatches, photographs, logos) are protected by intellectual property rights owned by United Press International. As a consequence, you may not copy, reproduce, modify, transmit, publish, display or in any way commercially exploit any of the content of this section without the prior written consent of United Press International.

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