In a provocative examination, financial expert John Mauldin addresses the relationship of the reserve currency status of the U.S. Dollar and the up and coming Chinese Renminbi. His article, The Renminbi: Soon to Be a Reserve Currency?, is an important analysis.
The doom and gloom predictions that the dollar is finished gets a rebuttal argument. While this viewpoint may seem a little too late, the actions of the Chinese Inc. continues to lay into place a more prominent international role for their RMB currency.
Mr. Mauldin paints a favorable resurgence in the domestic conditions because of the US energy boom in shale oil and gas and the renaissance in US manufacturing. Well, stats that support his argument would be welcomed, but overall strength in a viable and prosperous marketplace is still a long way off for most sectors of the economy.
Nevertheless, even if there is a sound rebound, in spite of the continued U.S. debt borrowing needs, confidence that the U.S. Dollar can maintain its historic role as the liquidity provider for the world is questionable. Conversely, the Renminbi is asserting a new and important role.
China is transforming into a financial center. Mr. Mauldin cites:
“The proposed development of the Free Trade Zone (FTZ) in Shanghai, covering 28sq km, will have huge consequences for China’s financial markets and that of the world. It will be a tax-free zone; the RMB will be fully convertible; the FTZ will have its own rules and regulations that cannot be trumped by central government; it will be legally outside the Chinese Customs, in fact a separate territory inside China; it has the effect of abolishing control over capital account investment, so allowing freedom to set up all kinds of companies and moving capital in and out of the FTZ, meaning in and out of China; it will become an international settlement centre for international trade and it will allow banks within the FTZ greater flexibility in conducting business.”
His summary conclusion includes:
“This move makes sense for China, as it is a large step toward eventually floating the currency, which is yet another requirement for a true reserve currency . . . Setting up a free-trade zone, as they propose in Shanghai, is a way to slowly let the air out of the balloon and perhaps even avoid the dramatic dislocations that might occur if they were to float the currency all at once.
Even so, internationalizing the RMB carries a lot of risk, so why does China really want to globalize its currency? Summarizing from a recent report from DBS Bank (based in Singapore), we can piece the picture together:
¦“China has experienced 35 years of relatively stable 10% GDP growth. It’s 28 times bigger today than it was in 1978. Why risk this kind of success for a globalized RMB and an open capital account?
¦The structure of the global economy has changed radically since 1978 while the financial architecture has changed barely at all.
¦Between now and 2020, China’s two-way trade will grow by $4 trillion. That’s nearly the size of the entire of offshore eurodollar market.
¦China doesn’t just want a globalized RMB; it needs one. The Middle Kingdom’s growth since the 1970s can largely be explained by mobilizing two key factors of production: land and labor. Now that economic growth is slowing in China as a whole (although there are still regional booms in some areas), Chinese policymakers hope they can regain momentum by mobilizing the last factor: capital.”
More evidence is provided in the article, China Maneuvers To Take Away US’ Dominant Reserve Currency Status.
China has already advanced the Yuan as a principal exchange currency by incorporating a series of deal with other countries. Such arrangements are hardly mentioned by U.S. financial media, but they are going on constantly. So far, the People’s Bank of China (PBOC) has signed nearly 2 trillion yuan worth of currency-swap deals with 20 countries and regions, including Hong Kong. Here’s a breakdown of happenings:
Earlier this month, the European Central Bank announced a large currency swap arrangement with China.
An Asian ”renminbi bloc” has been formed involving seven countries.
Russia, Iran, Angola, Sudan and Venezuela have converted oil sales to China into the Chinese Yuan. Worldwide, we see more than 5 million barrels per day traded in Yuan rather than U.S. dollars.
Thechinamoneyreport.com on June 16 reported RMB-yen trade is growing strongly a year after launch.
BBC News, April 9: “China and Australia in Currency Pact“
BBC News, Feb. 22: “UK and China Poised for Currency Swap Deal“
BBC News, March 26: “China and Brazil Sign $30bn Currency Swap Arrangement“
Thechinamoneyreport.com on June 4 reports that Singapore has launched a Yuan clearing service.
Although ignored in the U.S., there has been increased chatter among foreign media about the RMB (aka Yuan) reaching safe-haven, reserve currency status, as Asia Today reported on July 22.
So what does this all mean for the American consumer? Reports on international finance and currency relationships are not usually subjects for daily conversation. Even so, the implication on the cost of goods and prices for services is a topic that affects everyone.
The Chinese are essentially a creditor nation. “Foreign governments hold about 46 percent of all U.S. debt held by the public, more than $4.5 trillion. The largest foreign holder of U.S. debt is China, which owns more about $1.2 trillion in bills, notes and bonds, according to the Treasury.”
Whether the U.S. economy improves to reduce future borrowing is debatable. Yet, if an acceptable Renminbi for international settlement challenges the reserve currency status for the Dollar, the ability to sell bonds to foreigners for financing debt spending will be more difficult.
Low cost consumer prices are the first causality of a diminished purchasing power of your currency. The Renminbi is poised to play a far more important role in finance. This prospect does not mean that commercial transactions will not use the Dollar. However, if the price of oil starts accepting transactions in Renminbi, you know that your standard of living is ready for a sharp decline.
In that case, the US energy boom that John Mauldin envisions had better be real.
James Hall – October 2, 2013
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