Montag, April 06, 2009

The Story Of Two Currencies...

Ben Simpendorfer, Chief China Economist at the RBS, had a comment in today's WSJ that deserves some expansion and some thought about what the global reserve currency actually does and means.

First and foremost, let's not forget what a currency -  or money, I will use the two interchangeably, as they are the same thing for the purpose of this analysis - is: it is a means of exchange. Nothing more, nothing less: the devil is in the details. I will admit I don't know monetary theory like I know input-output or industrial stochastics and asymmetric equations, but what I do know is that money is first and foremost a matter of trust, of believing in money, rather than having money backed by something tangible, such as gold. Our entire world economy is based on this, based on what the monetarists call "fiat" money, i.e. money that is backed by governments. While the gold freaks see this as the incarnation of the devil - they would now, wouldn't they - it really isn't, as properly done can provide great stability and increases in wealth, both real and monetary.

The problem is when it's not done right.

The US dollar is the key currency world-wide. It's not so because some secret cabal decided that it should be so, nor because an open cabal decided: it became the world currency, replacing the pound sterling, because the pound sterling could no longer fulfill the role needed. The country with sovereignity - the country whose currency is the measuring stick for all others - has enormous advantages for the financial health of that country: after all, it no longer really needs to worry about balance of trade and foreign reserves to ensure that it has adequate access to the world currency to trade with.

But that really isn't the case, is it? Sovereignity is a wonderful thing to have, but you can lose it. The balance of trade is of critical importance in terms of keeping sovereignity and all its benefits, and is really the reason why even with sovereignity you need to watch your current account and trade balance: long-term inequalities here point to a country that may lose its sovereignity rights.


Because other nations lose trust in that currency. Nothing more, nothing less.

This doesn't happen overnight, it doesn't happen behind closed doors, it doesn't happen in open discussions, it most certainyl doesn't happen because lone bloggers say it's so.

It happens because of the ruthlessness of markets, who don't care about the importance of sovereignity, but rather where demand meets supply.

China is playing a growing role in discussions over solutions to current economic problems. Much of the talk has focused on money -- whether Premier Wen Jiabao's concerns about the value of China's U.S. treasury investments, or the People's Bank of China's paper floating the idea of a de-dollarized international monetary system. Up to now, one limit to China's ability to contribute to global monetary reform has been its own currency policy, particularly the fact that the yuan is not convertible. However, now there are tentative signs that's starting to change.

It's changing not because China wants it to: it's changing because people are losing confidence in the US dollar, which is happening because people are losing confidence in the US. More specifically, they're losing confidence in the US financial community, which is being (ab)used by the Obama administration as a national whipping boy, doing exactly the opposite of what is needed to maintain confidence, let alone reinstate it.

Beijing has signed currency swap agreements with six central banks: Hong Kong, Indonesia, Korea, Malaysia, Belarus and most recently Argentina. These swaps permit those central banks to sell yuan to local importers in those countries who want to buy Chinese goods. This is particularly useful for importers struggling to obtain trade finance as a result of the financial crisis. As such, it's consistent with China's desire to participate in the Group of 20's efforts to support trade financing.

This has everything to do about trade. That's all this is about.

China has long wanted its currency to play a more important role in the global financial system. These swap arrangements come in the context of that broader policy aim. The broader policy goal also has a more practical function in reducing currency exposure and transaction costs for Chinese exporters. The rise in the yuan's value relative to the dollar in early 2008 was a reason why some Chinese exporters went bankrupt. The ability to settle trade in yuan would reduce this risk in the future.

The markets are even more ruthless than the Gods of the Copybook Headings, and always will be...

Certainly the swaps should not be mistaken for full yuan convertibility. Details are scarce, but it appears the yuan cannot be sold for other currencies, in particular, the dollar. Neither can they be used by the other countries as part of their reserves to defend their own currencies, unlike the recent swap agreements several countries have signed with the United States Federal Reserve. In large part this is because the yuan is not fully convertible. Hong Kong remains the only place where it is possible to open yuan deposit accounts, and even there daily deposits and withdrawals are capped.

Hong Kong, Indonesia, Korea, Malaysia, Belarus and ... Argentina. The last is perhaps more political than anything else, but indicates who China wants to trade with...

Yet while the swap arrangements do not signal full convertibility, they are an important step in that direction. Even better, the Chinese authorities appear to have accelerated the reform schedule in recent months to suggest that the prospect of partial convertibility, especially between China and its major regional trading partners, may be closer than many believe.

In other words, the shift is underway: this will be, bluntly, devastating for the US. Losing sovereignity over the international currency is basic super-power trappings. Even the threat of losing it will create a seismic break in US politics, which would be a good thing: the Gods of the Copybook Headings are about to speak.

China's State Council announced its intention in December to permit businesses in specific provinces to settle international trade-related transactions in yuan with specific trading partners. Guangdong province can settle in yuan with Hong Kong and Macau, while Guangxi and Yunnan provinces can settle in yuan with members of the Association of Southeast Asian Nations.

Here the Chinese are, as always, practical: they're not going to even try to fight the markets, but rather go with them...


The transformation of the yuan into a global currency has begun. It will not be an overnight change, but the change may take place faster than expected. The economic crisis has provided China with a window of opportunity to leverage its relative stability and status as a trade surplus country to extend yuan credit to deficit countries globally.

This is how global currencies are born and die: demand for them. Nothing more, nothing less. The US dollar is increasingly on the verge of tipping over, exacerbated by the hugely irresponsible spending of the Obama Administration and the apparent desire to castrate the Financial sector in order to dominate it and force policy changes through that the market does not want.

Chicago politics at its best.

The implications are, as I've said, huge and devastating for the US: without sovereignty, the US will have to accumulate currency reserves and get its house in order. Expect this to be the greatest challenge to the US since probably the Civil War, as it will force the US to live within its means. Given the degree of parasitical infestation...

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