Can the Reasonable Alternative to the US Dollar Be the Chinese Yuan?

09/22/2014 5:30 pm EST

Focus: GLOBAL

Jim Jubak

Founder and Editor, JubakPicks.com

The US dollar is likely to continue to gain strength against other global currencies for a while, but MoneyShow’s Jim Jubak points out why a lot of portfolio managers are looking for alternatives and why one beneficiary may be the Chinese yuan.

If you buy your Treasury bonds in dollars, you aren’t reading your portfolio statements with a smile right now. US government bonds are down 0.45%—(including interest)—since June—in dollars.

In euros, however, they’ve returned 6.7% (including interest). That kills the 1.7% return for German Bunds, according to Bloomberg.

In yen, the return has been 7.6%. That is somewhat better than the 0.2% return in yen for Japanese investors in Japanese government bonds.

The mover here is the appreciation in the US dollar against the euro and the yen and just about any other global currency.

The disparity in return is likely to go on for a while since the US dollar is likely to continue to gain strength against other global currencies for the remainder of 2014 and into 2015.
But it also means that this trade—dollar denominated US Treasuries against just about everything else—is getting kind of crowded.

And that suggests that, while cash isn’t about to stop flowing into dollar-denominated assets—You’re going to pass up a 7% return in favor of making 0.2%?—portfolio managers are watching the growing size of their dollar positions with concern. And that, in turn, suggests that the move out of dollar assets is likely to be rapid—once portfolio managers can find a reasonable alternative.

There’s no evidence that this is happening now. Exposure to US dollar bonds is up at foreign central banks. The dollar positions held in custody by the Federal Reserve for foreign central banks hit a record $3.03 trillion last week.

One likely beneficiary of the search for alternatives to the dollar is the Chinese yuan. Even without the pressure exerted by a strong dollar and rising dollar positions, the markets have been seeing a steady increase in the sale of bonds denominated in yuan. But the pace has picked up in recent months. A big landmark was the September 12 announcement that the United Kingdom will sell debt denominated in yuan in the first-ever offer of a government bond from a country other than China to be denominated in the Chinese currency.

In the long-term, this is a major milestone in China’s efforts to raise the profile of the yuan as a global currency. In the short-term, the strength of the yuan presents a huge challenge to the People’s Bank, which faces the choice of letting the yuan appreciate and risk a slowdown in China’s economic growth or of intervening in the currency market to depress the price of the yuan at the risk of increasing the money supply and feeding credit growth in China.

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