Day after day articles pitching the Chinese Yuan as the next reserve currency appear on the Internet, almost as quickly as Chinese manufactured goods appear in U.S. ports.
Bullion.Directory precious metals analysis 14 October, 2014
By Terry Kinder
Investor, Technical Analyst
Chinese Yuan: The hype of the Yuan versus the reality of it becoming the reserve currency are two different things.
Image: pixabay
Just in case the idea of the Chinese Yuan as the next reserve currency wasn’t dead, Mike “Mish” Shedlock at Mish’s Global Economic Trend Analysis stuck a few more knives in the argument for good measure.
First, let’s take a look at Jim Rickard’s stunning critique of the “bloggy” Chinese Yuan as Reserve Currency meme.
Below is a list of Rickard’s critique of why the Yuan is not ready to be a reserve currency:
- U.S. treasury market is the deepest most liquid place to invest saving in the world;
- If China wants the Yuan to be the reserve currency it would need to build a sovereign bond market denominated in Yuan, but such a market doesn’t even exist yet;
- Said Chinese sovereign bond market would need issues in all maturities ranging from 30 days all the way up to 30 years;
- A sovereign bond market requires dealers to make the market, but China lacks both a sovereign bond market or dealers to make it’s non-existent market;
- In order for the bond market to function a payment and settlement system is required, but China doesn’t have one;
- Futures and options are required along with the bond market so that the bonds can be hedged;
- Repos are needed to finance the bond market;
- China has none of the above structure yet and it will take from ten to twenty years before they can build it;
- Even if China builds all of the above structure, they still need to instill confidence that contracts will be enforced and that requires the “rule of law”;
- China works under a Communist system and Communists don’t believe in the rule of law
Jim Rickards begins deconstructing the Chinese Yuan as reserve currency around the 26 minute mark of the video. You will want to watch at least from there to the end of the video because he unveils what China is likely aiming for through its current actions, and it likely has nothing to do with achieving reserve currency status for the Yuan.
After Rickard’s savaging of the Chinese Yuan as reserve currency meme, it didn’t seem like there was much more to say, but Mike “Mish” Shedlock took a stab at it.
Questions for Yuan Lovers
Please note that in spite of all the yuan reserve currency hype, one currency that is not freely convertible is the Yuan.
When will China have the biggest, most open bond market in the world? Next year? A decade? three decades?
I ask these questions because until China has the biggest, most open bond market, a freely floating currency, and it eliminates currency controls, there is no chance the Yuan will supplant the dollar.
And what about political freedoms and global trust? Will a centrally planned undemocratic economy like China ever get that trust?
In line with the above, Mish also quotes an email from Michael Pettis where Pettis writes:
China has a rigid, unsophisticated, and largely insolvent financial system with vague delineations between what is and what isn’t implicitly guaranteed by local governments or by Beijing.
Mish sums up the hype versus reality of the Chinese Yuan becoming a reserve currency quite well:
Hype vs. Reality
For all the hype, the Yuan trades as actively as the Mexican Peso. Yes, this will change, s.l.o.w.l.y.
Right now, the US Has …
- The largest, freest capital market in the world.
- The largest bond market in the world.
- A freely floating currency.
- Political freedom.
- Strong property laws.
- Democratic form of government.
Conclusion:
Chinese Yuan: What did the U.S. Dollar say to the Chinese Yuan? “Yuan a piece of me?”
Image: pixabay
However, China is currently not prepared to transform the Yuan into the world reserve currency. Currently China is aiming to make the Yuan a trade currency as it also accumulates gold. If you watch the Jim Rickard’s interview above, he states that China, though gold accumulation is, in effect, hedging its bets.
He says you should be buying gold too in order to hedge against the possibility of the U.S. attempting to inflate its way out of its debts.
This is, in fact, a much better reason to buy gold than the very remote possibility that the Chinese Yuan will somehow manage to become the reserve currency replacing the U.S. Dollar anytime soon.
While the Yuan as reserve currency idea has spread far and wide on the Internet, the likelihood of the Yuan replacing the dollar as the reserve currency is extremely low anytime soon.
You definitely should not focus on the Yuan displacing the dollar as a fundamental reason to buy gold. In fact there are many good reasons to buy gold, including a primary reason China is buying it, as a hedge against inflation.
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There has been a lot of hype around a “gold-backed yuan,” which some speculate as China feasts upon these gold prices. Rickards, also, said that China is buying much, much more than estimates suggest – maybe two to three times more!
Now, Rickards shot down the idea of a gold-backed yuan for the same reasons you mentioned above. However, I believe it is important to note that China also buys gold to hedge their massive dollar FX reserves. China wants to get out from under the dollar. To paraphrase a Chinese official, it’s a currency of debt.
China has a cultural relationship with gold, but the government somewhat promotes individual buying of gold because it hedges movements in the yuan.
In my option, we are heading to a period with no reserve currency. Dollars overtake international trade settlements at 82-84 percent, while the yuan has been nipping higher. Nevertheless, countries have been undergoing trade with local currency swaps.
As the Fed prints worthless money, faith in the dollar could be lost. Trade will likely be dominated in local currencies to limit dollar exposure. Very interesting.
China might not be a reserve currency now or in a few years, but the future holds many mysteries.