In the next decade, America and China, will be going head-to-head. The relative value of their monies – the yuan/ US dollar cross-rate – stands as the prize in the global economy.
For years the Chinese yuan was tied umbilically to the USD in a near-fixed ratio. But 2015 has already seen big changes, 2016 will see even greater moves.
Make no mistake, China is grappling for America’s currency crown. Much of today’s global economic power comes from seigniorage – the ability to force others to use your paper money – and the USD is the crossborder unit of choice.
But China is playing the long-game, set by precedent: America overtook the British economy in 1870, but it took eighty years before the US dollar surpassed sterling in international financial markets.
Three things happened in 2015. First, the USD has continued to appreciate, as currencies from the Euro to the yen, from Brazilian real to the rouble, and even gold, have tumbled against it.
Second, the yuan has struggled to keep up.The Chinese signalled a ‘minor’ three per cent devaluation in August, dressed-up as a technical adjustment.
Third, today the yuan was formally welcomed as a member of the IMF’s reserve currencies.
China wants two things from SDR recognition: To encourage the international economy to increase use of the yuan, and the ability to tap an international demand for yuan, to help her to get off an unhealthy dependence on the USD.
The vast markets of Central Asia and Indo-China are ripe for future Chinese economic expansion.This is China’s opportunity for seigniorage.
China’s current dollar-dependence is a key reason her economy is struggling. There is a shortage of dollars in the world economy and China is experiencing ‘cold turkey’-like withdrawal. China’s ranks of savers are simply not bailing out America’s profligate consumers. It is not America that is vulnerable, but China.
What is being missed are gross balance sheet positions. China may enjoy a net current account surplus, but she has simultaneously borrowed huge amounts of US dollars. In short, pegging to the USD has effectively dollarised China’s inflating domestic financial markets, and the scale of this bubble is eye-watering.
China’s asset economy, has grown by a whopping 12-fold since 2000, making it the biggest credit and capital spending boom the world has ever seen.
The net result is that investors are already accelerating their exit from China: US$700 bn has left in 2015, twice last year’s outflow of US$270bn.
The stark reality is that each dollar that leaves reduces domestic liquidity,amplifying the domestic credit crunch.
Our calculations suggest the Chinese currency may be already 20 per cent overvalued. Expect the yuan to fall in value, perhaps by a lesser five-10 per cent in 2016.
The Chinese currency is getting bigger in importance, but it will first need to get a bit smaller in value to fulfil its destiny.