As China’s currency becomes easier and easier to trade, and as its economy grows, it is becoming an alternative to the greenback. Here’s how investors can play the trend, writes MoneyShow’s Jim Jubak, also of Jubak’s Picks.
Throughout the global financial crisis—even as the problem changed its focus (and name) from the US mortgage-backed securities crisis to the Eurozone debt crisis—the United States could find solace in the strength of the dollar.
It may not have been a currency backed by the largest gold reserves or a well-run fiscal policy, but it needed only to be less bad than its global competitors. And up against a euro that threatens to come apart and a yen backed by a Tokyo government with an even bigger debt problem than Washington has, the dollar looked good enough.
For liquidity, for the depth of its markets, and for its ease of transfers and payments, the dollar was relatively strong, because the competition was relatively weak. The dollar was a global currency without real competition. That’s been critical to allowing US Treasury prices to rally and yields to fall even after the country lost its AAA credit rating.
The dollar isn’t without long-term competitive threats, however. The most obvious of those has long been the Chinese renminbi, or yuan. (China’s currency is named the renminbi. The units of the renminbi are the fen, jiao, and yuan. It takes ten fen to make a jiao, and ten jiao make a yuan. It’s as if the US currency was named the dollar, but its units were called the George, the Alexander, and the Benjamin.)
But that threat, while acknowledged as real, has always seemed very, very distant.
Well, I think it’s time to at least take one "very" off the timeline. China is moving more quickly than expected to turn its currency into a true global alternative.
How Far Can It Go?
It remains to be seen if the Beijing government can bring itself to give up the kind of control over its currency that would be necessary to turn the renminbi into a real alternative to the dollar.
China’s economic policies are so grounded in the government’s ability to control the exchange rate, and the flow of its currency in and out of the country, that the renminbi may never gain the currency market share that China’s economy and reserves could otherwise command.
But the global financial crisis—and the damage suffered by the euro, which had looked like a true alternative to the dollar before the European debt crisis—has pushed Beijing into action faster than projected even just a year or two ago.
Any real challenge to the dollar from the renminbi isn’t going to come tomorrow. But I don’t think investors should take the long-term supremacy of the dollar for granted. The likelihood of slippage in the dollar’s global role has implications for global stock and bond markets, for US interest rates, and for US economic growth rates that you should at least consider in formulating any long-term investment plan.
The latest move—announced just last week and set to take effect in the third quarter of the year—is, to me, a bombshell that indicates just how quickly the currency game is changing for the renminbi. (It also suggests a few stocks you might want to consider for your portfolio to take advantage of the long-term currency trend.)
But first: What happened last week?
The Yuan on the Block
It trades as 388.HK in Hong Kong, but Hong Kong Exchanges and Clearing (HKXCY) is very thinly traded in New York.
The company, which owns and operates the stock and futures exchanges in Hong Kong and related clearinghouses, announced plans to launch the first yuan-denominated futures in the third quarter of 2012. The new product would allow investors to trade against the dollar in contracts priced at $100,000.
Nothing new there. Lots of markets offer futures based on the US currency. But this is new and an important change: The contracts will require delivery in dollars by the seller and payment in yuan. In essence, then, the futures allow for the convertibility of dollars and yuan.
The move is another step in China’s project of creating a global offshore market for trading renminbi, which really got up to speed with the creation of an offshore market for renminbi in Hong Kong in mid-2010. Until then, the buying and selling of yuan had been largely limited to mainland China under the government’s strict currency controls.
From July 2010 to January 2011, daily trading in Hong Kong grew from zero to the equivalent of $400 million. Still a drop in the global bucket, but China didn’t stop there.
In January 2011, for example, the state-controlled Bank of China allowed customers to trade yuan in the United States. The move was an endorsement of the expansion of yuan trading by Beijing, but it came with the typical truckload of restrictions. Businesses can convert any amount of currency, as long as they are engaged in international trading, but US-based individual customers were limited to $4,000 a day.
In August 2010, McDonald’s (MCD) became the first foreign nonfinancial company to sell yuan-denominated bonds in Hong Kong. Since then, Caterpillar (CAT) and Volkswagen (VLKAY) have joined a parade of companies raising capital in yuan-denominated bonds in Hong Kong.
In spite of a slump in issuance in the fourth quarter of 2011, the value of new so-called "dim sum bonds" reached 104 billion yuan—$16.4 billion. That’s almost triple the offerings in 2011.
In December 2011, China and Japan agreed to conduct future bilateral trades directly in yuan. (In 2011, trade between China and Japan amounted to $350 billion.) Before the agreement, Japanese companies, like those from most other countries, had to convert payments into dollars and then into yuan. Each conversion imposed trading costs and exposure to currency fluctuations.
The real big bang, though, is scheduled for 2014, according to the People’s Bank. That’s when China will roll out a system that would allow countries to settle payments for Chinese goods in yuan instead of dollars.
With higher volumes will come lower costs—in the current system it costs more to do cross-border transfers in yuan than in dollars. That cost differential isn’t likely to persist for long, given the volume of its China’s global trade. International trade settled in yuan was just $371 billion in 2011.