Fear of a Yuan World

Japan fears the rise of the Chinese currency, should you?

Tue, Oct 16, 2012 - 10:00am

Last week’s IMF and World Bank meeting in Tokyo failed to accomplish much especially considering China, the world’s second largest economy boycotted the event due to the recent disputes over the Diaoyu island chains in the East China Sea.

lthough not much was accomplished, the meeting highlighted a future economic event that will transform the world we all live in. That event is the rise of the Chinese yuan or renminbi as a world reserve currency. Japan sees this coming…and they might be the first nation to publicly declare their fear of a Yuan World.

One of Japan’s largest industrial and economic newspapers, the Sankei Shimbaun, wrote an editorial coinciding with the IMF meeting that Japan should be wary of the Chinese renminbi, which is now emerging as a base currency in Asia. If a country’s currency becomes a measurement for goods or assets in other countries, it can generate profits easily and without effort they went on to say. The paper citied the U.S. dollar as a typical example of such a currency.

There are other countries not happy with the exorbitant privilege in the U.S. dollar. In 2011, Vladimir Putin was quoted as saying, “They are living like parasites off the global economy and their monopoly of the dollar.” He went on to say, “There should be other reserve currencies.”

The article from the Sankei Shimbaum went on, “If Japan lets the renminbi become a dominant currency in East Asia, Japanese businesses and financial institutions would hardly be able to operate on the continent without using the currency and could end up following China’s currency policy. Japan’s diplomacy and national security would also be endangered, even as its economy weakens.”

These currency issues are reason enough for Japan to be wary of a Yuan world. But is it premature to worry about such an issue? Do we all need to fear a Yuan World? I argue that it is just a matter of time before the Chinese Yuan or renminbi becomes the world’s dominant currency. It will rise on its own but a new dollar crisis could contribute to its rise much faster than is expected. Before the end of this decade we will all realize that we are now living in a Yuan world.

In previous articles, we have argued about the inevitable rise of the renminbi and the three factors that go into the making of a world’s reserve currency. As stated, these are: the nation behind the currency must have a large GDP, it must be a large trading nation, and the currency must be convertible. Let's look at each of these below.

1) China’s GDP: From $357 billion in 1990 to $7.2 trillion in 2012

China’s GDP is already the world’s second largest at $7.2 trillion in 2012. This GDP figure is up from $357 billion in 1990 and $1.19 trillion in 2000.

The IMF predicts China’s GDP will pass the U.S. on PPP basis as early as 2016. But even IMF estimates don’t factor in a huge rise in the RMB. Some analysts are predicting we could see the RMB double in value in the next decade as China follows the currency appreciation ladder similar to what happened in Japan and Korea. The RMB is up only 25% in the last 5 years but China is accumulating massive amounts of U.S. debt in order to hold the renminbi at these levels. A decade long appreciation of the RMB combined with 7-8% annual growth in China could leave the Chinese GDP figures far above U.S. levels as the latter continues to struggle for growth and monetize their debt.

2) China: The world’s largest trading nation

As for a large trading nation, China is already the largest in the world. Saudi Arabia’s largest customer for energy is not the United States but China. Russia, Germany, Japan, Southeast Asia, and Africa all have one thing in common and that is their largest trade partner, China. What is different in the trade relationship with China as compared to the U.S. is that these countries need Chinese exports and the Chinese consumer. The relationship with the U.S. is one of only a shrinking consumer market for their products. On top of that, you have to loan money to the U.S. in order to vendor finance Americans purchase of your goods. China’s positive trade position will bolster the position of the RMB.

3) China: The world’s largest creditor and RMB convertibility

China is now the world’s largest creditor. In 2010, the state dominated China Development Bank and China Export/Import Bank extended $110 billion in loans to governments and companies in the developing world. That is more than the World Bank and much more than the IMF loaned out in that time. The institutions in which the U.S. and the West have used to structure and control the global economy are getting smaller in comparison to their rivals in China.

China is now in the process of converting all of their trade with developing markets into RMB in order to internationalize the currency. Currency swaps have been signed with over 20 countries including Japan, Korea, and most countries in South America. Several of these countries are now keeping RMB as reserves in their central bank. The governor of the Bank of Korea last week called for “open ended” currency swaps with China so that U.S. dollars would no longer be needed for trade between the countries. Japan of all countries has also called for the same and has said "we should not be using dollars in trade transaction between ourselves."

The purpose behind these currency swaps is to use RMB in trade as opposed to dollars. Two years ago, less that 1% of China’s trade was conducted in RMB. Today, that number is 25% and the HSBC bank is predicting that in only a few more years that number will reach over 50%.

Dollar debasement will usher in the Yuan World

The entire developed world is in process of debt monetization through balance sheet stuffing in their central banks. They argue that money printing works despite thousands of years of economic history that would argue otherwise.

Economic history says inflation will be the result of all of this debt monetization. The first phase of the debt monetization since the onset of the 2008 crisis has seen inflation in Asia with the productive economies like China suffering double-digit inflation. Inflation might not remain contained in BRIC countries on the next round.

The productive economies of Asia and BRIC countries are now watching for the second tsunami of global money printing created inflation to wash ashore. In this next phase, Asian countries may choose to appreciate their currencies in order to get lower prices for oil, iron ore, and foodstuffs that their economies are highly dependent on. Thus, large importing nations may quickly move from a phase of so-called deflation to one of sustained high inflation as import costs rise. In fact, with oil prices up 5 times and health care and education costs up 3 times in the last ten years it is hard for anyone to argue about deflation even in the United States.

As the United States continues to monetize its increasingly dreadful fiscal position, inflation will not be able to be covered up any longer. The QE will stop, interest rates will rise and the U.S. will have to default, as they can no longer service their debt. It’s a mathematical certainty.

The world will eventually see a major dollar crisis with the reniminbi as a natural replacement. There will be no proclamation; there will no be opening ceremony for this change. It will just happen, as matter of fact, not unlike how the dollar replaced the pound after World War 2. There were no articles talking about how the dollar was replacing the pound as the world’s reserve currency, it just happened. And it happened quickly.

Fear of a Yuan World

The next major dollar crisis will usher in the Yuan world. That Yuan may be partially back by China’s gold production in order to gain acceptance. China continues to accumulate increasingly large hordes of gold year after year. For what purpose one can only speculate.

In this Yuan World, the United States will at that point have to start to live within their means. Can you tell 100 million plus able-bodied adults not in the workforce that their government transfer payments can no longer cover their living expenses? Will someone who is a third generation dependent of the state work 12 hour factory shifts for low pay?

Americans will have to go back to work but how much will it cost to rebuild those manufacturing plants? Will we even have the know-how or enough trained talent to do so? And how do you tell the world’s largest military still guarding the world’s sea-lanes that their currency is no longer valid?

There are many things to fear in a Yuan world.

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