This brings us to perhaps the fear most rooted in economic reality — fear of China. Once again it’s overstated and a bit of political science is warranted. China’s greatest value is stability. A precipitous decline in the U.S. dollar destroys that stability because China holds over $1 trillion in U.S. debt and more than that in its cash reserves. China won’t abandon the U.S. dollar, but rumors of that will persist.
Fear of a China slowdown is the only one that is valid from an economic point of view. China cannot sustain nearly double-digit growth without inflation, and it cannot suppress the pressure of wage inflation as its middle class increases.
The resulting strategy for approaching China would be to become adept at trading the AUD/USD, because the Aussie is a surrogate for Chinese growth expectations and will be impacted severely by any change in China growth. A clue to following China sentiment and its impact is to track the Shanghai Index against the Aussie currency (see "Crouching tiger"). The chart shows how weakness in the Shanghai index is holding the Aussie down despite its high interest rate differential from the other currencies.
Abe Cofnas is the author of "Sentiment Indicators" and forthcoming (fall 2011) "Binary Option Trading: Strategies and Tactics" (Bloomberg Press). He holds a master’s degree in political science and public policy from the University of Calif., Berkeley and can be reached at firstname.lastname@example.org.