Rising Chinese Redback Could Overtake Debased Greenback - Part 2

How Long Will the Greenback Last?

Wed, Nov 16, 2011 - 11:03pm

In part one of Rising Chinese Redback Could Overtake Debased Greenback published on Financial Sense in July of this year, we reviewed the major tectonic shift that is happening in the global currency markets with the rise of the Chinese currency, also known as the Redback or Renminbi (RMB).

This rise of the renminbi is starting to get focus in the mainstream media this week with the announcement from the U.S. China Economic and Security Review Commission’s 406 page published report to the U.S. Congress that said “it is no longer inconceivable that the RMB could mount a challenge to the dollar, perhaps in the next five to ten years.”

There is also now now open talk in the Chinese press of the eventual replacement of the USD by the RMB. In part one of this article, we talked about the major macro economic factors that would lift up the RMB and overtake a collapsed U.S. Dollar.

These major macro economic factors are massive government and trade surpluses, a high growth economy and a new China that has become creditor to the world as well as the world’s largest trading nation. We also talked about how large Multinationals are now holding some cash reserves in RMB and how foreign Central Banks have ordered RMB as well to hold as a reserve currency.

Since Part 1, there have been several major new developments. Nigeria announced they are moving 10% of their currency reserves into RMB and suggested they might move oil sales to China into RMB. Philippine Finance Secretary Cesar Purisima said in an interview on Sept. 3 that buying the yuan may be “prudent.” The Chinese government also announced London as an official offshore center in which to internationalize the RMB.

We have no doubt that the RMB will be mostly convertible by 2015, as it is clear China is rapidly accelerating convertibility.

In Part 2, we examine the mechanics of the 3 step process stated by China to make the RMB convertible. The steps to making the RMB convertible are identified by Chinese monetary authorities as follows:

Step 1: Is to make the RMB a global trade settlement currency

Step 2: Is to make the RMB an international investment/debt currency

Step 3: Is to make the RMB an international reserve currency

Step 1: Making the RMB a Global Trade Settlement Currency

Making the renminbi a global trade settlement currency will happen through emerging markets. China’s trade with emerging markets represents roughly 55% of China’s foreign trade. This number is sure to grow as emerging economies continue to grow faster than the so called “developed” economies. Despite China’s huge trade flows with emerging economies most of this business is conducted in USD.

China would like to switch this trade with emerging markets from dollars into renminbi. China has actively started this process. Currency agreements have been signed with a host of emerging market countries and more are on the way.

In addition to the table below, there are future currency swap agreements under discussion with the Philippines, Vietnam, Brazil, Thailand, and other countries.

Renminbi denominated trade was slow to start but is now gaining traction. Current projections for 2011 show that roughly 7% of Chinese trade will be conducted in renminbi which is a huge increase from 2010 when it represented less than 1% of China’s trade flows.

Step 2: Making the RMB an international investment/debt currency

The second part of the plan for internationalization of the renminbi revolves around making the renminbi an investment/debt currency. China's offshore bond market started in 2007 and in 2010 reached Billion. Global multinationals such as McDonalds and Caterpillar have now issued RMB denominated bonds also known as “Dim Sum’ bonds. In the future, as global multinationals invest in China they will not need to bring in USD but will be able to go into the RMB debt markets then invest the proceeds from those offerings. The Asian Development bank and the World bank have also issued RMB backed bonds. This is all part of a plan to slow down accumulation of USD in China.

These Dim Sum bonds have a very small value in terms of the global bond market but they are very symbolic of where the world is going. As U.S. interest rates increase, the future of the RMB bond market may provide an alternative market for debt with lower interest rates.

Step 3: Making the RMB an international reserve currency

When we look at the history of global reserve currencies they are not so much decided in meetings but rise out of the host countries natural economic strength. London had the reserve currency until two world wars had sapped its vital economic strength and the U.S. Dollar took over as the U.S. had 25% of global GDP and was the world’s largest creditor nation. The world needed U.S. manufactured goods and agricultural products. It made natural sense for the USD to become the world’s largest reserve currency. Today, however, the United States is the world’s largest importer and debtor.

Furthermore, the United States is increasingly unable to pay for their imports without printing money and has accumulated massive government and current account deficits. In the normal course of things it may have taken China twenty years to replace the USD as the host of the world’s reserve currency, however, since the economic crisis began the U.S. has committed to a self-destructive course by spending even larger amounts of borrowed money while running its printing presses at full-throttle. These decisions will no doubt speed the introduction of the RMB as the world’s reserve currency.

Recently, Xing Yujing, deputy director of the People’s Bank of China’s monetary department, said “The yuan already meets the conditions to be an international currency for reserve and settlements. It will play an important part in achieving close relations with emerging economies and establishing a new international monetary system."

We also saw this week that China will allow foreign companies to list on the Shanghai stock market and will be able to obtain RMB with these Shanghai listings.

The world changed while we slept, and there will be less and less need for the USD not only in China but maybe the rest of the world as well.

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