Planting the seeds of a new Asian reserve currency
Via Bill’s Shared Items, I encountered a People’s Daily article entitled “Renminbi likely to be used as currency for forex reserves” dated 12/25/2008. Wu Xiaoling, who is deputy director of the Finance and Economic Committee in the National People’s Congress, announced this pilot program to allow RMB to serve as a trade settlement currency between eight neighboring countries. Wu makes it clear that this is just the first step toward the eventual establishment of the RMB as an international reserve currency:
Prior to making the Renminbi, also called yuan, a currency used for forex reserves by other economies, it may be allowed to be used for trade settlements between China and some other countries and regions, according to Wu.
In China’s neighboring countries, there were calls for the yuan to be used to settle bilateral trade payments, she said. China has signed settlement agreements with eight neighboring countries, including Russia, Mongolia, Vietnam and Myanmar, assuming a voluntarily choice of settlement currency, she added.
Many were confident of the yuan and willing to settle trade payments in the Chinese currency, as it remained strong, Wu said.
The seeds of the future are being planted here. Whether the Chinese economy becomes the largest in the world in 2025, or 2040, there is no reason why China’s currency should not become a global reserve currency the way the USD, JPY, and Euro are today.
Global economic meltdown of 2008 has obscured the long-term trend toward RMB stability
In April, as the RMB:USD crossed the 7:1 mark, I posted about likely continued RMB appreciation and the likely emergence of RMB as a new Asian reserve currency. At the time, I was mostly concerned about the declining RMB-USD exchange rate and ways to hedge this risk. But while I was myoptically focused on my declining buying power in RMB terms, a new financial era was being born with the collapse of Bear Stearns and federally-guaranteed acquisition of the firm (for $2/share, off its $117 high) on March 17, 2008. The downdraft in the global economy has completely rendered obsolete these earlier concerns about general inflation, rising commodities prices, and hot money inflows.
In December, after a surprising drop in the RMB value in the early part of the month , foreign currency watchers became concerned about continued pressure to devalue the currency to support exports (see ChinaDaily article Think tank wants RMB devaluation) while Tao Wang, head of China Economic Research at UBS Securities, noted that China has “very limited scope” to keep its currency depreciating against the USD (source ChinaDaily) and predicted that the exchange rate could move to 7.0 by end of 2008 but return to about 6.8 at the end of 2009.
No question there is significant pressure on the government to provide relief to an economy addicted to export-led development. But devaluation vs. the dollar would likely have questionable benefit since it appears that Europe, not the US, has been powering China’s export growth since around 2006, according to Brad Setzer. Besides, its clear to everyone that the US consumer, as the engine of global growth, is completely finished. Andy Xie, of Caijing Magazine, also writes an excellent article on why RMB devaluation versus the USD is very unlikely. The only scenario where the RMB might devalue is if the USD reaches new highs relative to other major currencies. If not (and I think not), then 6.85 will be the new 8.27 (Brad Setzer’s nice phrase) for the foreseeable future.
Evidence of regional currency leadership even today
Setzer also highlights a regional deal between Chinese and Japanese central banks to save the Korean won. From Financial Times:
The currency swaps lines allow the authorities to tap funds and inject them into its markets when credit gets too tight. Under the latest deals, South Korea will have a 38 trillion won ($28.29 billion) currency swap facility with the China’s central bank, the People’s Bank of China. The yuan/won swap will be for three years but can be extended and, unlike an earlier $4 billion credit line for emergency use only, can be tapped at any time.
With the Bank of Japan, the yen-won swap facility is increased to $20 billion from the existing $3 billion. The two central banks have a separate, emergency-only $10 billion credit line in dollars.
South Korea has already used $7 billion out of a $30 billion currency swap with the U.S. Federal Reserve to help keep its money markets liquid and has smaller swap deals with some Southeast Asian central banks.
Note that the Chinese swap facility is similar in size to what the U.S. Fed has already provided to Korea.
And what will happen to the U.S. Dollar?
Niall Ferguson, in his article “What ‘Chimerica’ Hath Wrought” highlights a potential risk to the U.S. Dollar via a cautionary tale about the decline of the British Pound as the world reserve currency:
A second possible implication of the current crisis is that the days when the dollar was the sole international reserve currency may be coming to an end. Reserve currencies do not last forever, as the case of the British pound makes clear. Once upon a time, sterling was the world’s number one currency, the unit of account in which most financial transactions were done. It died a slow, lingering death, sliding from $4.86 in 1930 to very near parity with the dollar at the nadir in the early 1980s. The principal reason for that was debt: the huge debts that Britain had run up to fight the world wars. The second reason was lower growth: Britain’s economy was the underperformer of the developed world in the postwar decades, right down to the early 1980s.
Its quite possible that the flight to safety and the strength of the US Dollar in Q4 of 2008 will be the last gasp of the currency as it relinquishes its “exorbitant privilege” of being the world’s sole reserve currency. And while a “slow, lingering death” of the US Dollar may not be in the cards, its very likely that dollar decline and that the RMB will ride that decline down for a while as the Chinese government restructures the economy away from export-dependence. But ultimately, in the next growth cycle, the peg will loosen and the RMB will appreciate again.
Photo courtesy Caijing.com.cn.
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Links: RMB appreciation and the emergence of a new Asian reserve currency 
I’m STILL curious what CNReviews and Michael Pettis has in response to UBS’ Jonathan Anderson’s article arguing that China isn’t particularly an export-dependent economy.
Can you provide the URL to the article?
Why doesn’t the current account surplus and accumulation of foreign reserves speak for themselves? Doesn’t that indicate export dependence?
http://www.allroadsleadtochina.com/index.php/2007/10/01/is-china-export-led/
Thanks. Let me read it and provide a more thoughtful response. However, if indeed you, Rich Brubaker, and Jonathan Anderson is right, it means that the pressure to devalue is even lower than otherwise. In fact, its even more likely that the Chinese would hold the peg at a minimum and potentially let the RMB appreciate relative to the USD (and maybe even the EUR). With a stronger RMB, consumers and domestic businesses can buy foreign products cheaper which would help everyone feel richer, which presumably would add to social stability.
I don’t understand it enough to be right; I’m just interested in the viewpoints of others.
One retort I’ve heard is that a declining export sector necessary means increasing unemployment, and unemployment is a political problem, even if the economy at large ends up growing.
Seems to me that the goal of the RMB 4 trillion stimulus is exactly focused on reducing unemployment. The focus is on construction and infrastructure, because that can employ lots of labor.
Now wouldn’t it be interesting if Alaska, Hawaii, California, Oregon and Washington somehow got added to those “neighboring countries” where the RMB can be freely exchanged? When you think that the main currency used in China for trade in the 19th century was the Mexican trade dollar (because of its silver content), then that is not as wild as one may think.
The next step would be for those neighboring countries to start using the yuan for budget purposes. Then businesses will start accepting the yuan for settlements.
Then…
http://sec.online.wsj.com/article/SB123051100709638419.html
Its interesting that I have not been able to find a US bank that has multicurrency accounts. One of my banks, Everbank, has “fake” multicurrency accounts that use non-deliverable forward contracts of currency to simulate foreign currency accounts such as RMB or CHF. But as far as I know they don’t actually convert your account into foreign currency. On the other hand, the accounts are FDIC insured.
So I’ve been forced to set up accounts in Hong Kong and China in order to start moving USD into RMB.
I think the Russian guy is totally on drugs. I don’t think the model of a U.S. disintegration would break up on existing state boundaries probably more defensible physical security areas oriented around available natural resources including food and energy. But more importantly, I think people like this Russian guy underestimate the amount of national cohesion that would keep the country together. I’m not so worried about U.S. disintegration. I am worried about uncontrolled borders with Mexico, peak oil, global warming, dollar decline and hyperinflation, and global shortage of water, food, oil and commodities. But NOT yet diverting personal funds into agricultural land, bullets, and gold coins.
There won’t be any hyperinflation in the classical sense in the US, period.
Hyperinflation defined in the classic economic sense means 100% and above inflation, and it is in fact NOT a type of inflation, it is currency failure, implying government failure. Hyperinflation always preceded regime change (which we saw in Weimar, ROC China, and will see in Zimbabwe very soon).
What kind of countries suffer from hyperinflation? It doesn’t necessarily have anything to do with monetary policy, it has a lot to do with the country’s inherent resources. Weimar lost the WWI and its most productive regions as a result, and owed GOLD, not Deutsch Mark which it could print. ROC China was a semi-colony just coming out of an 8-year national war with most infrastructure impaired, and food supply constrained.
The US owes USD, and frankly has the biggest guns in the world, nobody can really force the US to pay up. US is also the bread basket of the world accounting for 60% of the total food export, and ranks in top 5 in almost every kind of mineral deposit.
A persistent inflation of 20-40% will be most beneficial for the US and that is what the Fed is shooting for. Will they overshoot to induce hyperinflation? No, because hyperinflation simply doesn’t happen to a country of this kind of profile. Of course American lifestyle will take a hit, but we have been living on excess for so many years, and this is not a bad thing to begin with.
In times of extreme uncertainty which we all will be facing, it boils down to two things: Food and Gun, food to keep yourself alive, and gun to protect your food.
So the countries that will come out of this in the best shape will be those with the most resources per capita, with a minimum population of xx million that can support an adequate military force to defend their resources, or when things get real ugly, can offend to take more resources from weaker hands.