China’s World Reserve Currency in a World of Its Own
Perhaps you caught it?
About five weeks ago, in The Edelson Wave, I wrote Keeping the Faith in the US Dollar.
I made the case the Chinese yuan has a difficult road ahead – STILL – if it is to unseat the U.S. dollar as the world’s primary reserve currency.
I did, however, make a minor concession: that if the U.S. dollar’s stranglehold on global oil pricing were threatened, the U.S. dollar’s decline could be expedited.
Not long after my article was published, rumors surfaced (again) that indeed China would be able to take away some proportion of petrodollar flows. The resulting alternative would be something like a petroyuan.
But fair enough.
Yet still not that easy.
A brief mention in my article remains the inconvenient truth for China and its global aspirations: The Unholy Trinity.
Also known as a trilemma, the unholy trinity states that China cannot have a fixed foreign exchange rate, free capital movement (absence of capital controls) and an independent monetary policy all at the same time.
It may be able to control two at a time, but not three. China wants to eat its cake and have it too.
For anyone who thinks they can, consider recent headlines:
CNBC: CHINA’S DEBT IS GROWING AT A FASTER PACE DESPITE YEARS OF EFFORTS TO CONTAIN IT
FINANCIAL TIMES: CHINA’S GROWTH MIRACLE RUNS OUT OF STEAM
BLOOMBERG: CHINA BANS UNLICENSED MICRO-LENDING, CURBS RATES TO LIMIT RISKS
The thing is, no matter how much I harp on these facts – debt is producing less growth, GDP must go down for sustainability reasons, the shadow banking system is fraught with risk – it doesn’t matter much in the context of healthy global risk appetite.
But sure enough, this next headline caught my attention and screamed for me to write this update:
BLOOMBERG VIEW: MAYBE CHINA SHOULDN’T OPEN UP
It grabbed me because “opening up” is a prerequisite if China – and especially its currency – is going to unseat the U.S. and the U.S. dollar as global hegemon.
Not that I care which country lays claim to “Master of the World.” I just think we should have a better grasp of the basics before we start forecasting historic power shifts.
The most obvious implication of opening up is that China’s central planners lose the ability to control important pieces of the financial system and economy, namely capital flows.
From the Bloomberg article:
“China has avoided a financial crisis precisely because its banking system is closed and its regulators can restructure liabilities at will. Removing constraints on capital flows would strip the government of the weapons needed to defend against a crisis.”
When China talks up its reform efforts and its 30-year plan – or whatever – we must realize it will expose their vulnerabilities.
And the first whiff investors get of a China that can’t be closely managed as it has been during the happy times of the last 20 years will be the next shock to capital flows – it will remove many unstated incentives for investors to pursue China.
If you’re making any big bets the Chinese yuan is reserve currency material, perhaps reconsider.
And if you’re making any bets at all in China, beware that a global flight to safety will probably hit China’s markets harder than other big players.
If you believe, as I do, that global equity bull markets are on the cusp of a major correction, then betting against China will soon present a good profit opportunity. When the time is right, consider the Direxion Daily FTSE China Bear 3X ETF (YANG) that moves inversely to an index of Chinese large cap stocks.
Currently, you have open bearish positions in crude oil, gold and U.S. Treasuries.
I recommend you hold all positions.
I am contemplating adding some exposure to the bearish gold trade. But wait for my instructions next week when I send a position and market update.