(Corrects penultimate paragraph to show index up 25 percent not 60)
By Mike Dolan
LONDON, Aug 5 (Reuters) - Western governments seem set on preventing currency appreciation snuffing out nascent economic recoveries, helping reignite bets on a devaluation of major currencies against those of the emerging economic giants.
And with the dollar weakening again, the push to convince China and the emerging economies to take a greater share of its depreciation may well be back on the table at the next G20 finance chiefs meeting in London on September 4 and 5.
For investors, the near-term growth outlook alone, where the International Monetary Fund expects developing countries to outstrip mature economies almost eight-fold next year, is compelling enough even before they consider more powerful 10-20 year outlooks of emerging economy outperformance.
And with stabilisation of the world economy in the first half of 2009 fast turning into an upswing in global industrial production, there has already been a scramble to rethink market positioning and to reconstruct reflationary trades.
So-called interest rate carry trades, the life-blood of pre-crunch currency markets, are back in vogue -- taking advantage of falling volatility and near zero interest rates in major economies -- borrowing cheap dollars, euro and yen to buy high-yielding currencies everywhere from Turkey to South Africa.
But central to the "normalisation" trade so far this year has been a sharp unwinding of U.S. dollar gains made in the dash for cash and liquid U.S. Treasury securities during the worst of the credit crunch after Lehman Brothers collapsed.
"The normalisation trade still has an upper hand. Everyone seems to be emerging from bunkers looking to revive old plays," said Paul Lambert, macro strategist at hedge fund Polar Capital. "How durable it is from here is another question."
ONLY HALF DONE
On the face of it, this great dollar unwinding looks only half complete.
The dollar index has retreated just 13 percent after a trough-to-peak surge of some 25 percent between August last year and March 2009. And that tallies with fund-tracker EPFR's estimate of a net $200 billion of outflows from safe-haven money funds so far this year versus $460 billion of inflows in 2008.
On that evidence, further dollar losses look likely.
That's especially so if you believe the U.S. Federal Reserve will be slow to tighten its zero interest rate policy into the upswing and that world central banks are diversifying their hard cash reserves away from what they see is a vulnerable dollar.
"The US currency (is) likely to remain chronically weak in an environment of normalised risk appetite and compressed G10 yield differentials," Credit Suisse told clients this week.
"However, with many G10 currencies now approaching stretched valuation levels, we are increasingly selective in trading our dollar bearish view."
And here's the rub -- many developed economies, faced with the same severe credit shock and unemployment surge as the United States, are not prepared to tolerate further dollar depreciation this time around and are resisting.
The Swiss National Bank has actively intervened to sell francs for dollars since March and there has been a chorus of protest from Australia to New Zealand to Sweden and elsewhere.
With euro/dollar at its highest levels this year, euro zone officials are widely expected to start expressing concern about the impact on the recession-hit region.
So, if further dollar weakness is to resume, it may have to come against big emerging markets which --led by massive Chinese economic stimuli-- are outpacing developed world economies.
Looking at the biggest emerging markets of Brazil, Russia, India and China, some of this is already happening.
BRIC BELLWETHERS
In dollar terms, MSCI's BRIC equity index has surged a massive 71 percent this year -- far outstripping the near-20 percent gains in MSCI's world index and even the stellar 51 percent gains in MSCI's broad emerging markets index.
But BRIC currency performance on its own is more mixed.
Brazil's real leads the pack this year with gains of more than 20 percent -- but remains 16 percent down on a year ago. Russia's rouble has regained some of its extreme losses since March, but is also down 32 percent from a year ago.
The more obvious anomalies are in China and India - expected by the IMF to grow 8.5 percent and 6.5 percent respectively next year compared to 0.6 percent for the developed world.
India's tightly controlled rupee has nudged up about 2 percent in 2009 but is still down 13 percent over 12 months.
China's pegged yuan has barely budged against the dollar over the past year after being allowed to gain 17 percent in the previous three years. But the $185 billion in hard cash reserves China has accumulated in 2009 is a good proxy for the scale of upward pressure on the yuan Beijing has resisted.
This resistance to currency appreciation is political and difficult to second-guess, but it will likely return to the agenda at the G20 meeting next month and sits awkwardly with China's growing acceptance of the need to rebalance its economy.
But for investors, the clearing of the fog may allow them to look again at longer-term horizons
Goldman Sachs, which first coined the BRIC term, has developed a tradeable FX index based on trades that bet on a rise of the BRIC and next five big emerging currencies against a G10 currency bloc, including interest carry into the equation.
The index rose about 25 percent in the nine years to the onset of the crunch in 2007 but levelled off since but Goldman insist the attraction of the play is stronger than ever,
"The strength of the underlying fiscal position of emerging economies relative to the developed world is incredible and maybe the relative shift going on is even bigger than we first thought," said Jim O'Neill, chief economist at Goldman Sachs.
(Editing by Richard Balmforth)