Monday, June 11, 2018

PRC's Great Currency Game, or Nothing Special?

The story that dollar debasement going forward will occur is a familiar one. TIME even has a photo essay comparing present-day America with Weimar-era Germany. One certainly hopes this comparison isn't apt for a number of reasons, but you certainly cannot rule it out. Life is a cabaret, old chum. Much has been made in recent days of China's proposal to diversify out of dollars which the US has certainly done everything humanly possible to debase; this point is not really under much contention outside of neo-Bushian "strong dollar" comments from Obama administration officials. This new Reuters article notes that the bluster behind China's call for a new reserve currency would amount to little if it weren't for the PRC's other currency ploy which has not attracted that much attention.

Drudge Report readers and other yokels are certainly unaware that China is busy signing swap arrangements with other countries outside the context of the Chiang Mai Initiative with ASEAN+3 countries (which has evolved to being more regional from its origin as a series of bilateral swaps). Reuters sees this process as China being more assertive on the economic diplomacy front. With a real long-term view--think 25, 40, 50 years down the road--the Chinese are playing a great currency game which Americans can't, fixated as they are on a four-year election cycle:
The political intent of Zhou's message [on elevating the status of SDR to true reserve alternative] could not be clearer: as the crisis of capitalism erodes U.S. influence, China is losing faith in the dollar and sees the time ripening for the yuan to assume its rightful role as a major world currency. "It has the potential to lead to one of the most profound reforms of the global monetary system in the coming decades," Jun Ma, Deutsche Bank's chief China economist, said of Zhou's blueprint.

However, with 5,000 years of history behind it, Beijing is ready for a long game. Zhou knew his trial balloon would immediately be shot down, save for backing from Russia. Hence his acknowledgement that creating a new international monetary order would require "extraordinary political vision and courage".

Translation: Beijing realizes that a currency does not lose its global domination overnight. Even after the United States overtook Britain in economic size in the late 19th century, it took two world wars that drained Britain's Treasury and its military might before the dollar supplanted sterling. The American grandmaster will not surrender his title lightly...
And here's the novel part, unbeknown to most except the most informed (like my dear IPE Zone readers; also this brief blurb):
...Zhou's essay takes on a different complexion if read in the context of a flurry of moves by China in the usually dull arena of trade finance.

Since mid-December, China has sealed currency swap accords totaling 650 billion yuan ($95 billion) with the central banks of South Korea, Malaysia, Indonesia, Hong Kong, Belarus and, in a deal announced on Monday, Argentina. These are pawns that are not being moved at random, and financial diplomats say more agreements are in the pipeline.

The proximate purpose is to grease the wheels of trade, which have been gummed up by the global credit crunch. Importers in the six countries will be able to pay for Chinese goods in yuan instead of in dollars, the principal export-import currency. But the potential repercussions for global currency politics are more far-reaching: if Asia got accustomed to the practice, the yuan could evolve into a regional currency, giving Beijing the status and influence that goes with it.

A former senior international monetary official said the pacts were in keeping with what he said was China's greater assertiveness in global forums over the past two years or so. "They want to play a stronger role, and these small steps such as giving bilateral swaps to Indonesia, Malaysia and Korea are a lot more important than the SDR proposal," said the official, who declined to be named as the issues are sensitive.

Getting comfortable with the internationalization of the yuan for trade should, in turn and in time, make Beijing more willing to move toward capital account convertibility -- a precondition for the yuan to become part of a revamped SDR.

Now, there is no sign China wants to speed up the opening of its capital account -- even though the yuan, if it could be bought and sold for non-trade purposes, would be more attractive for central banks as an alternative reserve asset to the dollar. But, as some economists see it, pricing and settling trade in yuan will inevitably lead to greater use of the Chinese currency offshore for financial and investment purposes.

"The swaps should be seen as a political statement with the intention of turning the yuan into a regional reserve currency," said Ben Simpfendorfer with Royal Bank of Scotland in Hong Kong.
Already there are pilot efforts in Hong Kong to see if settlement can be performed in yuan on a wider basis:
Take the scheme, due to be launched soon, that will allow trade between Hong Kong and the mainland province of Guangdong to be settled in yuan rather than in U.S. or Hong Kong dollars. The 200 billion yuan swap that Beijing signed with Hong Kong in January will provide an initial pool of Chinese currency needed for paying export and import invoices in yuan.

But imagine if the experiment takes off: banks would eventually need access to the mainland interbank market for funding, according to a financial diplomat in Beijing. And should banks in Hong Kong -- and other centers -- be allowed to adjust their positions with each other? If so, an offshore interbank market in yuan would sprout.

"We must understand that it is an inevitable trend that an overseas yuan investment market will grow after foreign trade settlement in yuan becomes widely accepted," Ye Xiang, a co-founder of VisionGain Capital, a Hong Kong investment management firm, wrote in Caijing magazine.
There are terribly plenty obstacles that China faces if it wants the yuan to be an eventual contender for a dollar replacement including classic functions of money--store of value, medium of exchange, and unit of account. Of course, unlike the dollar, the yuan is not yet freely traded, has no large international capital market, is subject to currency controls, and is not yet accepted by other countries for trade settlement. Indeed, I am still unclear on the mechanics of these swap arrangements as China would effectively have to loan yuan in order for other countries to pay in yuan. China is gradually putting these pieces in place if you believe Reuters, setting the stage for a showdown in a couple of years' time:
Many pieces will need to be moved around the board before China is in a position to force a draw with the dollar, let alone declare checkmate. But Beijing, thinking strategically, is unlikely to be too perturbed if Zhou's gambit founders in London [at the G20 meeting].
Also read this article from Bernama on how Indonesia is keen on seeing China take on a more aggressive role in global economic affairs. Certainly, there is no lost love between the US and many other countries like Indonesia. As I've mentioned many times, Indonesia believes it was hurt by the worst of Washington Consensus-style policies of fiscal austerity and belt-tightening during the Asian financial crisis whereas the US now splurges in troubled times because it can by drawing on the dollar's status as the preeminent reserve currency.

Would a world where the dollar loses its prominent role be a better place? The debate rages on. And I love a cabaret.

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