One of the most significant financial events is taking place before our very eyes, and yet not many are paying attention to it, says Louis Gave, CEO of the well-respected GaveKal Research.
After the Lehman collapse in 2008, firms around the world suddenly canceled orders to China, causing Chinese exports to collapse by 30%. With the US dollar acting as the world’s reserve currency, greasing the gears of international trade, suddenly those dollars became scarce as the US banking system paralyzed credit around the globe. This led China to ask, “Why should badly managed banks in the US affect our trade with other countries?”
Not wanting to suffer the same consequences again, China has since responded by conducting trade agreements with its partners to trade not in the world’s reserve currency, the US dollar, but with its own currency: the renminbi. As a result, “In the past five years, China has moved from 0% renminbi and 100% US dollars to, now, 18% denominated in renminbi. That’s a massive, massive change,” says Gave.
“The internationalization of the renminbi, the creation of the RMB bond market, is one of the most important financial developments of the past decade,” he says.
One to way to understand this major shift taking place is to compare it to what happened in the 1970s. “If you look at Europe in the 40’s, 50’s, and 60’s,” Gave says, “Europe was very much a US dollar zone—everybody worked in dollars, everybody saved in dollars, everybody traded in dollars. And then of course the US started to debase their currency between Johnson’s Great Society and the Vietnam War. The Europeans complained and told the Americans, ‘You guys are printing too much,’ to which Treasury Secretary Connelly told the Europeans, ‘Hey, the US dollar is our currency and your problem.’ So the Europeans said, ‘Fine, we get the message. If that’s the case, we’re moving our trade to the deutschmark. And we’re moving our savings into deutschmark.’ And over ten years that’s what happened. Here, you’re having the same story again. The US with their QE policies have told the rest of the world, ‘The US dollar is our currency and your problem.’ And the emerging markets are responding not by adopting the deutschmark this time, since it no longer exists, but by adopting the renminbi instead.”
Does this mean the US dollar is doomed? Quite the opposite. Instead, Louis lists a number of structural headwinds for the Chinese economy that may slow internationalization of the renminbi over time. The US, on the other hand, faces a falling trade deficit, manufacturing boom, and a revolution in automation and robotics, all of which bode well for the dollar in the foreseeable future. In light of these factors, Louis says the process of replacing the US dollar in global trade will be a slow and gradual process, but one that global investors need to take seriously.
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