Why rising paper costs mean a falling dollar

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The dollar had a steep fall at the end of last week, as the US imposed import tariffs on coated paper made in China.

NewPage, the biggest producer of quality paper in the US, had complained that its coated paper - which is used in glossy catalogues, among other things - faced unfair competition from Chinese imports. The competition is deemed unfair because the paper companies get "improper subsidies" from the Chinese government.

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Although there have been plenty of trade disputes between the US and China before, this one is particularly important for reasons we'll elaborate on below.

So why did the dollar react so badly? Well, that'll be because China imports a lot of paper from the US too - government debt, mainly. And if this dispute marks the start of a trade war, and China decides to stop buying, the dollar could fall a lot further

US import tariffs on Chinese coated paper, ranging from 10.9% to 20.4% will take effect from this week, announced US commerce secretary Carlos Gutierrez on Friday.

It's significant because this is the first time that trade sanctions based on illegal subsidies have been placed on a communist, or non-market economy, like China. US companies have always been able to complain about "dumping", whereby Chinese (or other) goods are sold in the US below their production cost.

But for the past 20 years or so, US policy has been that companies can't ask for penalty tariffs based on unfair government subsidies from China - mainly because it's pretty much impossible to define what an improper government subsidy is in a communist economy.

All that has now changed - and Guttierez said the sanctions may be considered for other industries.

"It doesn't seem the best way to handle the issue," David Watt, a currency strategist at RBC Capital Markets in Canada, told Reuters. "The US still needs a lot of investment from abroad, especially from Asia, and it's not clear what type of impact such measures will end up having on consumers and on the US economy."

It certainly isn't a good way to handle the issue. For one thing, cheap Chinese goods are the main deflationary force offsetting high raw material costs - if Chinese imports get more expensive, inflation will rise, which makes any chance of a US interest rate cut later this year even more remote.

Perhaps even more important is that China imports a lot of paper from the US - in the form of dollars. It's sitting on more than a trillion dollars-worth of foreign currency in its central bank vaults, and analysts reckon about 70% of that is greenbacks.

If the Chinese decide they can do without that particular type of paper, that'll send the dollar lower, putting even more inflationary pressure on the US.

The Chinese certainly weren't happy about it. "It's unacceptable and China strongly demands the US to reconsider the decision," said China Commerce Ministry spokesman Wang Xinpei.

But there are plenty of people who don't particularly care. As Martin Crutsinger of the Associated Press reported: "The action was being closely watched by many other American companies, from steel to furniture, that were battered in recent years as Chinese imports flooded the country." They'll all be pressing Guttierez to do the same for their industries.

It's understandable that people want to protect their jobs and their businesses. But unfortunately, cheap Chinese imports are one of the main things propping the US economy up. If the current imbalances between the US and China unravel rapidly , it'll be painful for both sides - but for the dollar in particular.

"Protectionism news is never dollar-positive," said Kathy Lien of DailyFX.com. "The market is not over-reacting and there is a strong possibility that China will retaliate."

So how can you profit, other than by shorting the dollar? One beneficiary of a falling dollar, and Chinese currency diversification is likely to be gold. If the Chinese are looking for other places to put their reserves, gold's an obvious choice - while a weakening dollar is traditionally good for the yellow metal. You can read lots more on gold, by clicking here: Investing in gold.

Turning to the stock markets

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In London, the FTSE 100 closed 16 points lower on Friday, at 6,308, as a downturn on Wall Street hit investor sentiment. Vodafone was the day's biggest faller, its share price declining over 6% following warnings over declining profitability. For a full market report, see: London market close.

Across the Channel, the Paris CAC-40 closed just two points higher, at 5,634, whilst in Frankfurt the DAX-30 ended the day 19 points higher, at 6,917, with support coming from financial stocks.

On Wall Street, stocks closed mixed after a session marked by volatility. The Dow Jones finished Friday 5 points higher at 12,354 and the tech-heavy Nasdaq ended the week 3 points higher at 2,421. However, The S&P 500 lost 1 point to close at 1,420.

In Asia, the Nikkei closed 259 points lower today, at 17,028, as economic concerns weighed.

Crude oil had fallen back to $65.40 this morning and Brent spot was also lower, at $67.90, in London.

Spot gold had climbed to $664.30 this morning, and silver had fallen to $13.36.

And in London this morning, Britain's seventh-largest bank, Northern Rock, announced that it is expecting a profit increase of 18% in 2007 as conditions for the UK mortgage market remain 'supportive' despite rising interest rates. Northern Rock is also likely to avoid the bad debt problems which have hit peers including Barclays and Lloyds TSB as the vast majority of its lending is secured by properties. Northern Rock shares had fallen by as much as 0.4% to 1,140 this morning.

And our two recommended articles for today...

Is Britain's wealth an illusion?

- Britain doesn't manufacture much and hardly mines or farms anything, yet in many ways we've never had it so good. But how strong are the foundations of our service-based economy? If you'd like to read more about whether current prosperity can last, click here: Is Britain's wealth an illusion?

How China could trigger a dollar decline

- Yet again, the market has over-analysed and over-reacted to the latest statement from the Federal Reserve, says Paul van Eeden, when investors should be paying more attention to China's dollar reserves. To find out why he also thinks China has a crucial role to play in the future value of the dollar, read: How China could trigger a dollar decline

In London, the FTSE 100 closed 16 points lower on Friday, at 6,308, as a downturn on Wall Street hit investor sentiment. Vodafone was the day's biggest faller, its share price declining over 6% following warnings over declining profitability. For a full market report, see: London market close.

Across the Channel, the Paris CAC-40 closed just two points higher, at 5,634, whilst in Frankfurt the DAX-30 ended the day 19 points higher, at 6,917, with support coming from financial stocks.

On Wall Street, stocks closed mixed after a session marked by volatility. The Dow Jones finished Friday 5 points higher at 12,354 and the tech-heavy Nasdaq ended the week 3 points higher at 2,421. However, The S&P 500 lost 1 point to close at 1,420.

In Asia, the Nikkei closed 259 points lower today, at 17,028, as economic concerns weighed.

Crude oil had fallen back to $65.40 this morning and Brent spot was also lower, at $67.90, in London.

Spot gold had climbed to $664.30 this morning, and silver had fallen to $13.36.

And in London this morning, Britain's seventh-largest bank, Northern Rock, announced that it is expecting a profit increase of 18% in 2007 as conditions for the UK mortgage market remain 'supportive' despite rising interest rates. Northern Rock is also likely to avoid the bad debt problems which have hit peers including Barclays and Lloyds TSB as the vast majority of its lending is secured by properties. Northern Rock shares had fallen by as much as 0.4% to 1,140 this morning.

And our two recommended articles for today...

Is Britain's wealth an illusion?

- Britain doesn't manufacture much and hardly mines or farms anything, yet in many ways we've never had it so good. But how strong are the foundations of our service-based economy? If you'd like to read more about whether current prosperity can last, click here: Is Britain's wealth an illusion?

How China could trigger a dollar decline

- Yet again, the market has over-analysed and over-reacted to the latest statement from the Federal Reserve, says Paul van Eeden, when investors should be paying more attention to China's dollar reserves. To find out why he also thinks China has a crucial role to play in the future value of the dollar, read: How China could trigger a dollar decline