Thursday, December 16, 2010

The great straddle inches wider

In the last two days, both the FT and WSJ have carried stories about a burgeoning global trade in the yuan. The FT was first out of the blocks:
In spite of its infancy, interest in the market is growing quickly. Caterpillar, the US-based maker of earthmoving equipment, launched a Rmb1bn ($150m) bond issue last month, making it the second multinational to tap the market, following an August issue by McDonald’s, the fast-food chain.

What makes these bond issues important is that the offshore renminbi market is much more than just a new avenue for debt financing – it is one of the core components in a plan to internationalise the Chinese currency. The process will be a slow one, with more baby steps than giant leaps, and it is by no means assured that the renminbi – also known as the yuan – will forge a decisive international role. But it is one that could have a huge long-term impact on trade, the global financial system and even international politics.

If the plan works, the renminbi could become the main currency for doing business in Asia, the world’s most economically dynamic region, and in the long run it could become a significant part of the reserves of the world’s central banks. Indeed, some Chinese officials have already called for the renminbi to be included in the International Monetary Fund’s basket of main currencies.

The timing is also full of portents. The renminbi is starting to go global just as the future of the euro is looking increasingly uncertain. Eventually the shift could have an impact on the ability of the US to borrow overseas in its own currency. In China, some have taken to calling their currency the hongbi, or “redback”, to rival America’s greenback – a moniker that gives a flavour of the geopolitical undercurrents.

“We may be on the verge of a financial revolution of truly epic proportions,” says Qu Hongbin, China economist at HSBC, one of the banks pushing the renminbi to its corporate clients. “The world economy is, slowly but surely, moving from greenbacks to redbacks.”

This blogger can't get quite so excited about a "redback". China will need to be running gigantic current account deficits before there'll be demand enough for the yuan to begin to replace the greenback.

But that doesn't mean this shift isn't momentous. It is. Largely because the emergence of a new reserve currency backed by an export economy instead of deficit spending will put a great deal of pressure on the US to reign in said spending. If it can't rely on the endless cash flow of dollars in global capital markets to keep its borrowing costs down, it will have no choice but to embrace more disciplined fiscal policies.

And according to the FT that is precisely why Beijing is moving:
Yet the financial crisis has changed attitudes in Beijing and bolstered support for China to seek a greater international role for its currency. Officials argue that the crisis came about because the international monetary system allows the US to run unsustainable current account deficits. As a result, over the past year Beijing has put in place some of the conditions for the renminbi to go global.

This is confirmation (if any were needed) that the emergence of the yuan as an international currency is firmly in the realms of international relations and realpolitik not just economics. A US that is constrained by the borrowing conditions of ordinary nations can no longer afford to be a global military power.

And this may pose questions for Australia's Great Straddle sooner rather than later. As the FT recounted, one of the first steps in the internationalisation of the yuan is through Chinese bilateral trade:
The first step has been to encourage international trade to be conducted in renminbi. That process accelerated in June, when China expanded its year-old renminbi trade settlement scheme to every country in the world and to 20 Chinese provinces and municipalities, allowing imports and exports to be invoiced and settled in renminbi.

Even if the use of the currency is to be limited to trade, companies and banks still need to be able to hold and invest renminbi offshore – which started to become possible in some scale from July when the authorities allowed renminbi-denominated financial markets to spring to life in Hong Kong. A month later, a select group of investors, including foreign central banks, were given limited access to China’s onshore bond market. Malaysia is believed to have become the first central bank to hold mainland renminbi assets in its reserves.

The effect has been dramatic. The People’s Bank says trade settled in renminbi totalled Rmb340bn between June and November – from zero just a year and a half ago. The pace has stunned senior western bankers who know the region. Renminbi deposits in Hong Kong banks surged 45 per cent in October to Rmb217bn – another reflection of the use of the Chinese currency in trade.

For Chinese companies, the attractions of settling cross-border trade in their own currency are clear. Avoiding the dollar allows them to cut transaction costs and minimise foreign exchange risks – a huge benefit in a world at risk of a global currency war.

This blogger is not so sure for Australian miners. Pricing commodities in $US has been a huge boon for commodity prices as the monetary effect of its falling value has manifest in rising $A dollar prices. Mind you, this has been offset to a degree by the large rise of the Australian dollar against the greenback. The effects might be roughly even.

Certainly bilateral pricing of commodities in yuan would take away some of volatility and hence hedging costs. It may not be without its benefits.

But these considerations are anyway beside the point. There is little chance of the Australian government endorsing trade in yuan, for the geopolitical reasons described above. We're a US ally and to throw so extraordinary an insult at our Great and Powerful friend is strategically inconsistent to say the least. It wouldn't be easy to hide behind the fig leaf of "market forces" at work.

An excellent reason for China to ask us to do it.


Septimus said...

The Renminbi going global is no surprise, it started months ago with earlier Trade deals, and got into high gear when China refused to play ball with currency re-valuation. China is going to leave the principal OECD economies to drown in their own excesses, while China leads Asia to World economic dominance.

And, yes, Aus will, sooner or later, be put in a position where it will have to play the game China's way, or not at all. And that's no choice, really.

Not a pretty future.

Septimus said...

And Oh! -- If anyone was thinking that India might stay aligned with the West, forget it - China just bought them!

Anonymous said...

Surely trading with China in their currency is exactly the big ticket item that "Our Kevin" would love to have his name next to in the history books? Might even start to make up for some of the names he's been caught calling the Chinese of late..