Investors were alarmed by a report this morning that a top Chinese government official said China would shift its foreign currency reserves away from the “weak” United States dollar, further eroding confidence in the currency and sending it to a new low against the euro.Just a few weeks ago, in one of his last speech's before handing the reigns of the IMF over to Dominique Strauss-Kahn, Rodrigo de Rato warned of a potentially unsettling plunge in the greenback's value.
Up to now, movements in exchange rates have been orderly and in line with fundamentals. But there are risks that an abrupt fall in the dollar could either be triggered by, or itself trigger, a loss of confidence in dollar assets.
Are we watching Rato's dire prediction unfold before our eyes? Events like today's add weight to Thomas Palley's call for managed exchange rates. If, as Palley suggests, the US is getting out-gamed by savvier players in currency markets (ahem, I wonder who that could be), then perhaps it's time to start considering "outdated" approaches. Especially if they can restore a measure of fairness to the current exchange rate system. Thus far, the pain of the credit crisis in the US has been somewhat offset by the continued buoyancy of financial markets. But there will be a rising chorus calling for change if the so-called "real economy" starts to get sucked under. That corner may have been turned today.