2014-05-27

How Much Yuan Devaluation Can the Americans Bear? Communist Charles Schumer Won't Like It; More Reason to Own Gold

The U.S. dollar is doomed as reserve currency for the same simple reason the Swiss franc could never serve as the global reserve currency: the national economy will be too small for the future global economy. In order to fund the world's need for reserve assets, the U.S. must run an increasingly large trade deficit, and if the deficit were to continue growing, it would lead to a currency crisis.

On the flip side, the U.S. can't cut its trade deficit too much as long as it remains the printer of reserve assets. The world doesn't want to see the U.S. suddenly cut its deficit and reduce its need for money printing. The slowdown in emerging markets in 2013 was partly a result of the taper talk and the current slowdown in China is part of it as well. Almost everyone is stuck because the global imbalances are so large that no one is willing to bear the cost of reform, except for countries in unique positions such as India. The Chinese complain about U.S. debt levels, but if the U.S. actually cut its debt the U.S. trade deficit would drop and the renminbi would rise in value (it's still mainly dollar backed), guaranteeing a deflationary crisis in China. A U.S. government that actually behaved responsibly would be a taper on steroids.

This is why the U.S. is working with the IMF to replace the U.S. dollar with SDRs, as explained in Jim Rickard's excellent Death of Money. It is also why China's government is loading up on gold. Any misstep and the system is going to collapse before world leaders can find a solution, and given negative social mood is leading to increased tensions, the window for global coordination is also closing. On the current path of international relations, forget Bretton Woods III: the world may be headed for a full fledged financial war. This is why it makes sense to hold physical gold: there may not be a global fix for the world financial system and even if there is one, the enmity between China, Russia, the U.S. and other powers may be so great that a centralized solution, such as the IMF issuing SDRs as global central banker, may not last. In the absence of such a solution, gold is the obvious fall back reserve asset of choice.



It's also important to point out that while China wants the yuan to be a reserve asset, China doesn't want to be the reserve currency because then it would get all the problems that come along with it. It also doesn't want the yuan to be a reserve asset too soon because then the U.S. would press it to behave as its equal in financial matters, donating equal amounts for global financial bailouts and truly opening its markets. Finally, China's financial markets are nowhere near large enough to serve as a credible alternative yet, though the growing muni bond market helps. Ironically, if China did experience a huge financial crisis right now, it would accelerate the internationalization of the renminbi through devaluation (which would remove the devaluation fear that prevents the opening of the capital account) and a massive increase in the amount of Chinese debt assets, which could serve as reserve assets.

Now to the Chinese articles. The yuan fell again today and the PBOC midpoint hit an 8 month low. The questions being asked include: how does a weak yuan affect the U.S.? How much can the U.S. bear?

Here is an article on 5 ways the devalued yuan affects American wallets: 人民币走弱可能影响美国人钱包的5种方式. I enjoyed this bit:
Communist party member Charles Schumer of New York has also been concerned about this issue, whether the RMB is to appreciate or depreciate, the Chinese government should let the market decide and should not intervene.
That is not a mistranslation.

There is also this article asking how much can the U.S. bear? It mainly looks at the rise of the renminbi and the gold market in Shanghai, nothing new for China watchers.
美元能忍人民币多久?
According to foreign media reports, U.S. dollar is deeply threatened by the renminbi, there are indications that it will one day be its equal. 

Someday in the future of China's economy will be close to or exceed U.S. influence.

Russian President Vladimir Putin visited the first day of China, Bank of China and Russia signed the non-dollar settlement agreement, the two banks are Russia's second largest bank VTB and Bank of China, the two sides will invest in banks, inter-bank loans, trade finance and capital market transactions to domestic currency transactions. This means that the two banks in future transactions, you will no longer need to use the U.S. dollar.

In recent years, many countries are gradually reached a consensus gradually reduce the dollar in the areas of trade, investment and other payment settlement and the proportion of reserves to eliminate the negative effects of dollarization and currency mismatch brought about by a decrease of $ issued flood hazards. Russia continues to expand bilateral currency settlement means that the two big powers in this direction has taken a solid step forward.

Face gradually embarked on the world stage in RMB , U.S. dollars deeply felt threatened, competitive currency this space there is a great potential growth, there are indications that it will have the ability with which rival.

With the internationalization of the Chinese yuan, the use of the renminbi market is gradually expanding, each renminbi cross-border business and offshore renminbi clearing center have sprung into being.

People's Bank of China website data recently released data show that as of March 2014, foreign institutions and individuals holding domestic RMB financial assets amounted to 3.56 trillion yuan, compared with 2.88 trillion at the end of 2013 increased by 682.7 billion yuan. Which holds stocks 319.287 billion yuan, 512.349 billion yuan bonds, loans and deposits of 746.843 billion yuan 1.983982 trillion yuan.

This is the first published case of the Bank of RMB assets held by foreign investors to the outside world. While in the first quarter of devaluation of the environment, foreign institutions and individuals holding financial assets remain within the renminbi was expansive trend.

"With the continuous advance of RMB internationalization process, the distribution channels of more cross-border capital flow." UBS Wealth Management chief investment strategist at aquiline China recently said, "Although the first quarter yuan fluctuate significantly in the short, but foreign institutional investors people do not think that the RMB will continue to depreciate, and long-term bullish on the RMB exchange rate . "

Legg Mason's Western Asset Management portfolio manager Desmond Soon also pointed out that overseas central banks to hold renminbi reserves are steadily increasing demand, because the yuan is increasingly being used for trade settlement among.

However, faced with blooming yuan, some analysts said the yuan is still far failed to challenge the dollar's status, let alone replace the dollar.

Professor Dyson College of Cornell University Svalbard - Prasad wrote that London and Frankfurt, the world's major financial centers are eager to conduct RMB business, China has undoubtedly played an important role in international trade and finance. Recent speculation that the outside world, China's economy will soon overtake the United States or to further enhance the interest of his country for RMB business, also prompted many people believe that the RMB will soon dominate the global.

However, the article points out, the lack of a factor yuan to challenge the dollar: the global trust in China. In order to achieve monetary dominance, China needs economic strength. In this regard the dollar has a great advantage.


In the wake of the global financial crisis, the situation is particularly evident. Despite the near-collapse of the U.S. financial markets, public debt levels rise, the Fed was forced to launch a large-scale expansion of monetary policy to support the economy, but compared to most other currencies, the dollar is still strong.

This is because the global economic turmoil, investors seeking a safe haven and around the purchase of U.S. Treasury bonds. Despite the low U.S. Treasury yields, but global investors now hold more than $ 5.7 trillion of U.S. Treasury bonds, in addition to a number of other U.S. assets. Since the financial crisis, the U.S. share of global foreign exchange reserves of the share has remained stable.

Of course, along with the internationalization of the yuan and Shanghai to build the vault FTA, China's influence on the precious metals market will also be growing, the next day the Chinese economy will be close to or even surpass the U.S. influence.

Kyle Bass says renminbi devaluation is a possibility.

Kyle Bass On China's "Contraction" And "The Fed's Worst Nightmare"
China’s economy isn’t just slowing down, according to Bass: It’ contracting. While China’s published rates for annual growth are still positive, Bass said the nation’s economic growth was negative from the fourth quarter of 2013 to the first quarter of 2014.

That is a result of excessive government spending on unproductive sectors of the economy. Bass said the People’s Bank of China (PBoC) has been more aggressive in its quantitative easing (QE) that the Federal Reserve has, but much of that money has gone into unproductive credit expansion.

China’s banking assets have grown to over 100% of its GDP in the last three years, according to Bass. If the U.S. had engaged in similar policies – which he said would translate to $17 trillion in lending over that time period – it, too, would have achieved more than 7% GDP growth.

China’s banking assets now total approximately $25 trillion, or almost three times the size of its $9 trillion economy. Its low default rate on bank loans – about 1% – is about to rise, according to Bass. Much of that lending is construction-related. Bass said that 55% of China’s GDP growth has been in the construction sector. The marginal return on those loans must be very small, he argued.
“A rolling loan gathers no loss,” Bass said, “and that’s what’s been going on in China for the last few years.” He said it is impossible to believe China could “manipulate” the inputs of its financial system without losing control of the outcomes.

Deflation is also threatening China. Bass said that its GDP deflator is now below zero. He expects the PBoC to engineer a devaluation of the renminbi as a way to stimulate exports and avert further deflation.

Bass said that if non-performing loans go from 1% to historical norms “somewhere in the teens” with loss severities of 100% for the worst loans, then China would delete its $4 trillion of foreign exchange reserves. Bass implied that China would need those reserves to stabilize its banking system, though he did not say so.

China’s leaders are fully aware of the dangers its economy faces, Bass said, and they hope to slow growth in a measured fashion, including through the restructuring of its banking system. “The jury’s out whether or not they can do it,” he said. “We actually believe they might be able to do that and that GDP [growth] is just going to slow down a lot more than people expect.”

“I’m not saying it is a calamity, a disaster or it’s going to end badly for the world,” Bass said. “All I’m saying is China is slowing down a lot faster than people think, and you need to think about how to position your portfolio for this.”

Bass advised against shorting Chinese equity as a way to capitalize on his forecast. Instead, he said, investors should look at China’s trading partners – Australia, New Zealand and Brazil. Those countries will be forced to loosen their monetary policy, raising rates and creating carry-trade opportunities.

I expect Chinese equities will reach their nominal and possibly real bottom either just before or just after devaluation of the renminbi.

1 comment:

  1. I think it needs to be asked why a reserve currency even "needs" to exist.

    Hopefully they have no success with SDRs or else this extend and pretend game could go on for another 50 years.

    - Luke

    ReplyDelete