Could East African Bankers Solution to Inflation Foreshadow China's?

Three countries in East Africa—Uganda, Tanzania, and Kenya—are experiencing high rates of inflation. These countries have seen their currencies depreciate severely over the past year. The currencies of Kenya and Uganda are the worst performing in Africa, year-to-date. According to Reuters, analysts are predicting additional selling pressure on the African currencies unless short-term interest rates in the economies of these nations jump. Uganda is taking steps to combat its currency's depreciation. Bloomberg reported on Tuesday that Uganda's central bank sold U.S. dollars to strengthen the Ugandan shilling. The currencies may be depreciating due to the nations' reliance on foreign imports. Traders may view these economies as relatively unimportant. They are certainly minuscule on a global scale. However, the economics being experienced in these countries might shed some light on what is to come for major economies. Uganda is selling its stockpile of dollars to prop-up its currency and therefore reduce inflation. China is currently experiencing a massive inflationary problem and has a large stockpile of dollars. Would China, like Uganda, sell dollars to stave off inflation in its economy? Data released on Tuesday showed that China has already reduced the rate at which it is acquiring new dollar denominated assets. Instead, China is opting to purchase European assets with the fruits of its large trade deficit. Should China opt to sell down its dollar stockpile, it could tremendously depreciate the U.S. dollar while simultaneously causing an appreciation in its own currency, the yuan. In that case, U.S. consumers might have a difficult time making ends meet. An appreciating yuan and depreciating dollar may lead to higher fuel costs and more expensive prices at large Chinese importers like Wal-Mart WMT. Of course, that might have a severe negative effect on China's economy, as it would make it more difficult for China to export. Thus, China may resist selling dollars for the time being. Still, in the long run, they may have no other choice. Action Items Bullish: Traders who believe that China will follow Uganda's lead one day, and sell dollars, might want to consider the following trades:

• Buy Wisdom Tree Dreyfus Chinese Yuan Fund CYB in a long yuan play. If China moves to appreciate its yuan to stem inflation, CYB may do well.
• Short Power Shares DB US Dollar Bullish Index UUP in a short dollar play. If China sells U.S. dollars, the dollar could suffer, and UUP may do poorly.

Bearish: Traders who believe that China will be forced to sit on its dollar assets to protect its exports may consider taking positions in the following:

• iShares Lehman Aggregate Bond AGG is a long play on U.S. bonds. If China continues to stockpile dollar-denominated assets, AGG may be a smart investment.
• ProShares Short FTSE China 25 YXI is a short China play. If the Chinese economy does well, YXI may rally sharply.

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