From the currency war front, we are watching the major assault on the dollar. We have anticipated this move for several months now and it appears the major push by China has now been launched. The first signals was China NOT buying all of the US T-Bills at the last few auctions. Then they shifted their paper buying to the Euro bills. Now according to Graham Sharkey, only a mere twelve days into the New Year (2011) and China has already set the wheels in motion to use their most powerful weapon, the Yuan, in order to combat inflation. This may well be the first decision of many that will result in the Yuan being phased in as the new world reserve currency.
A stronger exchange rate will be the tool that China will use in order to tame their inflationary problems at present. The biggest increases being felt as a result of inflation at this time are; the Chinese housing market, which was most dramatically affected in the southern industrial hub of Guangzhou, where home prices soared by 38 percent in the past year. Another sector heavily affected was Chinese groceries, with the cost of some foods increasing by 50 percent.
In an attempt to address the loose lending policies being adopted by Chinese banks, China’s government have ordered their banks to increase the amount of money that each bank holds in reserves with a reduction in the availability of lending. The strengthening Yuan will essentially result in two ways; 1, their imports will become substantially cheaper. 2, their exports will be more expensive.
This is a move that the US have not wanted the Chinese to take as most of the consumer goods that are stocking up US stores are Chinese-made products and the longer the Chinese allowed their currency to be held at a relatively low-level (compared to its purchasing power potential) the longer the shopaholics’ in America could continue to buy their products at a price that they could afford (or a level that they could get credit for). So, with the world outside China continually devaluing their currencies and China increasing theirs who is going to pick up the export market? And how do they intend to do this?
Before hand, the countries that were importing goods from China were benefiting from a manipulated Yuan price which gave the illusion of cheap imports. But now, that is not an option. The only way that I can see that will enable countries to bridge the export gap will be, further devaluation of their paper currency, which as any respecting economist knows is only an extremely short-term solution (if it can even be called that) and will only result in long-term high inflation for that economy.
This currency policy decision by the Chinese government will help to add to the increasing confidence in the Yuan as a world reserve currency contender to replace the failure that is, the US Dollar. Aside from the measures taken to combat inflation in China, there have been many other recent events that all point to the strengthening of the Yuan and the growing popularity of the currency.
In the last two weeks, the World Bank issued their very first Yuan bonds; they will release the amount of 500 million Yuan, which is around $70 million in US Dollars. The bank has said that, these actions are an act of confidence in the Renminbi and will give investors around the globe the opportunity to diversify and help the exposure of the Yuan in global markets. The bonds were offered from January 14th, 2010 and will mature after two years in 2013.
In July of last year (2010) China began allowing cross-border exchange with the renminbi, however, there were caps on exactly how much currency was allowed to be exchanged. That was the closest China had come to allowing the renminbi to be a top currency on a global scale, until now.
Now marks the beginning of the renminbi being allowed to be traded in the U.S, China have identified that the global economy has become too reliant on the Dollar and wants to provide an opportunity to move away from that. China have already implemented strategies that will allow for sustained appreciation for the Yuan against the US Dollar, a prediction in the rate of appreciation was projected at 6% in 2011 by Robert Minikin, who is a currency strategist at Standard Chartered based in Hong Kong.
The reason that there hasn’t been a replacement of the US Dollar as the world reserve currency as of yet is the fact that there was no currency that was ready to take on that mantle, however, given the performance of the Yuan in the last two years, it has shown its power and reliance as a solid currency, not only that, but China have also helped their cause by not relying on a paper, fiat currency but actually using the strengthening Yuan in which to buy up gold and other major assets, something that every single country in the so-called ‘advanced’ world has not done. All of these factors are now helping to shape the Yuan into tomorrow’s new world reserve currency and once this transformation occurs, it really will spell the end for the down but not yet out, Dollar.
What to watch now is the so-called “summit meeting between President Obama and Hu Jintao of China this week. In preparation for that meeting, President Hu Jintao said Sunday the international currency system was “a product of the past,” but it would be a long time before the yuan is accepted as an international currency.
Hu’s comments, which came ahead of a state visit to Washington on Wednesday, reflected the continuing tensions over the dollar’s role as the major reserve currency in the aftermath of the US financial crisis in 2008.
“The current international currency system is the product of the past,” Hu said in written answers to questions posed by The Wall Street Journal and the Washington Post. Highlighting the dollar’s importance to global trade, Hu implicitly criticized the Federal Reserve’s recent decision to pump 600 billion dollars into the US economy, a move criticized as weakening the dollar at the expense of other countries’ exports.
“The monetary policy of the United States has a major impact on global liquidity and capital flows and therefore, the liquidity of the US dollar should be kept at a reasonable and stable level,” Hu said.
China’s own currency, the yuan or renminbi (RMB), is also expected to be a bone of contention in Hu’s talks with Obama, with the United States complaining that it is artificially overvalued to boost Chinese exports. Asked about the view that appreciation of the yuan would curb inflation in China, Hu suggested that was too simplistic a formula. “Changes in exchange rate are a result of multiple factors, including the balance of international payment and market supply and demand,” he said. “In this sense, inflation can hardly be the main factor in determining the exchange rate policy,” he said.
At the same time, Hu signalled no imminent move away from the dollar as a reserve currency, saying it would be a long time before the yuan, or renminbi (RMB), is widely accepted as an international currency. “China has made important contribution to the world economy in terms of total economic output and trade, and the RMB has played a role in the world economic development,” he said. “But making the RMB an international currency will be a fairly long process.”
Nevertheless, Hu noted that China has launched pilot programs using the yuan, or renminbi, in settlements of international trade and investment transactions. “They fit in well with market demand as evidenced by the rapidly expanding scale of these transactions,” he said.
As we have chronicled in this blog, these moves are demonstrating how short the fuse really is on the Dollar remaining the world’s transactional currency. With the European Central Bank(ECB) denying the crisis of the Euro and the US simply printing more money to cover the mess in the financial markets in the US, it is just a matter of time before China drops the hammer and we will be living in a very new economic paradigm. Watching the currency transaction markets, it seems it is a lot closer than anyone is admitting publically.