A major tectonic shift in global finance and economics is happening as we speak and it could affect geopolitics and global finance for decades to come. That shift is the rise of the Redback, or the renminbi. The Chinese currency is being powered by massive government and trade surpluses coming out of China as well as a high growth economy.
On the other side of the hill is the U.S. dollar being dragged down by massive U.S. government deficits, endless trade deficits, and rapid dollar debasement through the Federal Reserve printing press.
The Chinese currency, the renminbi or what some people call the “Redback” is rapidly becoming a new global reserve currency and in the future could replace the Dollars position as the preeminent global reserve currency faster than we can imagine.
Foreign multinationals in Europe are now holding large cash positions offshore in renminbi. Central Banks around the world such as Malaysia have ordered renminbi to hold as a reserve currency.
HSBC Bank predicts that if the current trend continues, that at least half of China’s trade flows with emerging market countries could be settled in renminbi within 3-5 years, from less than 3% currently. In other words, nearly USD2trn worth of trade flows could be settled in renminbi annually, making it one of the top three global trading currencies.
In the halls of the financial community the Chinese renminbi is considered a one-way bet which will no doubt appreciate against the U.S dollar. There seems to be no easy change of direction as the U.S. government will continue to struggle with massive government and current account deficits combined with zero percent interest rates. Some would argue the U.S. has already defaulted as the Federal Reserve has purchased such a massive amount of Treasure Bills.
When historians look at what constitutes a global reserve currency they have defined three key criteria.
- The country must have a large GDP.
- The country must be a large trading country.
- The currency must be convertible.
CHINESE GDP
China’s GDP hit $6 trillion in 2010 which was the second largest GDP in the world compared with a $14.7 trillion USD GDP for the United States. Yet, if we take a “real world” economic view at the GDP numbers they do not do justice to the comparison of these two economies. For starters, China uses more energy than the United States. They produce ten times the amount of steel than the U.S. does and produce and sell twice as many cars. In addition, China is the world’s largest exporter. What then constitutes the large discrepancy between the U.S GDP numbers and the China GDP numbers?
The U.S. has turned to calculating consumption as GDP. In other words, you fill up a Japanese car with Saudi crude and go to Wall Mart to buy Chinese goods using printed government transfer payments….and that is American GDP.
Regardless of the validity of using the GDP numbers in comparing the two economies, China’s GDP is already the second largest in the world and growing at 8-10% annually which would certainly qualify it as a potential host of a world reserve currency.
CHINESE TRADE
For any currency to become a world’s reserve currency the host country must be a large trading nation.
China became Japan’s largest trade partner in 2009 replacing the United States. China then overtook Germany to become Russia’s largest trade partner in 2010. In 2011, China is expected to overtake the U.S. as the EU’s major trade partner.
In South America, China replaced the United States as Brazil’s largest trade partner. The U.S. had been Brazil’s largest trade partner for the last 80 years. China also has very close relationships with the “Red” countries of South America which include Venezuela, Ecuador, Bolivia, and Peru. They have also become Chile’s largest trade partner.
It is also no secret that China is dominating trade and investment flows in Africa and are now Australia’s largest trade partner.
These kinds of trade flows will easily qualify the renminbi as a world’s reserve currency.
CHINESE CURRENCY CONVERTIABILTY
For the last issue of currency convertibility, China is now ramping up the internationalization of the renminbi to free itself from the ‘dollar trap’ and better facilitate long-term growth and reduce its dependence on the U.S. dollar.
They are making the currency convertible in three stages. The first is to make the RMB a global trade settlement currency; the second an international investment/debt currency; and the third an international reserve currency. We are currently well underway on the first two steps on the 3 step plan.
Indeed the leadership in Beijing now realizes the renminbi is the only currency in the top twenty economies to not be convertible. This is a shame and a loss of face that Beijing intends to correct as soon as possible.
In addition, by keeping the renminbi non-convertible and keeping the defacto managed currency peg against the USD it has created large economic imbalances not only in China but across the globe. This has led to China holding a massive amount of currency reserves which are now well over $3 Trillion USD.
In fact, China becoming by the largest international creditor to the United States has no longer become a source of pride in China but a source of shame. They call this phenomenon “Rich country-poor people” as in China’s case and “Poor Country-Rich people” in the case of the United States. They ask themselves why they should continue to struggle so hard to make mortgage payments and buy basic necessities while the Chinese government loans such huge amounts of money to the U.S. government who in effect just print the money. This is becoming a hot political potato for the government and it appears that there is only one solution which is to break the RMB-USD peg and get the currency convertible as soon as possible.
There is increasing consensus that Chin can absorb a large currency revaluation. First, there is still a direct labor shortage on the east coast. Secondly, despite large wage and manufacturing costs in China recently, domestic demand is more than making up for lost exports in textiles and other manufactures.
This new found Chinese currency convertibility may take the form quickly in “basic convertibility” which would mean an individual could convert up to 5 Million RMB with no questions asked or a corporation could convert 50 million or more without any special permission. There will be restrictions on the size of convertibility at least for the first few years of the opening up of the currency.This will allow Beijing to control speculation and chaotic changes in the money flows.
In summary, as China overtakes the United States as the world’s largest economy it makes complete sense that as the largest economy, largest trading nation, and the worlds largest creditor nation (as opposed to the worlds largest debtor nation) it would also have the most important world reserve currency. In fact, one day we might see the Chinese renminbi replace the U.S Dollar as the defacto AAA standard.
