Wednesday, March 27, 2013

The Coming Euro-Yuan Switch

The Cyprus shakedown has revealed more cracks in the euro structure and continued kowtowing to the banker and bank bondholder desires rather than the citizens of the euro members. The ECB has installed plenty of Goldman Sachs cronies in positions of power throughout the EU, so we know who is in charge. The latest grasp at depositors' money, private property, may been a step too far. I did not support its creation over a decade ago, and I am more confident know that we will see 2020 arrive without the euro. The big winner out of this will be China. Talk is always of China becoming the reserve currency. That is a multistep process and if possible, will be a choice of their making. By 2020 with the global debt issue in the rearview mirror*, China's yuan (renminbi) will be a reserve currency.

China's Yuan does not trade internationally. The Chinese need to develop their foreign exchange markets (Hong Kong can handle that). China has been making bilateral trade agreements with raw material suppliers as well as giant economies like Japan to trade without the need for the dollar, directly with the yuan (source). While a bit of an unknown, trading this much directly with their currency gives the world exposure of holding the yuan. Once used for trade on a consistent basis, the next step would be for countries to hold some reserves of it for exchange rate fluctuations. Another route China is pushing is to set up a bank outside the framework of the IMF and World Bank with BRIC leadership. The reveal of the prestige as magician's call it will be the late '10s announcement that China's gold holdings are audited and on par with America's claims.

At the current rate of domestic production and importation, China will surpass America for official gold holdings in 2018 (article estimating gold increase). If the euro disintegrates at roughly the same time, whether new or not to the international reserve currency scene, the yuan will be a likely alternative to take the euro's place. One could argue the euro's numbers will be split by the European countries, but don't be so sure. As the dollar lost value in the 2000s the euro rose as part of global reserve holdings. I can see German Marks having value as a reserve currency, but a yuan backed with the world's highest gold reserves will be a tempting reserve currency. What will petroleum exporters do? Will the Saudis and other gulf states fall under the Chinese protection umbrella in exchange for using the yuan for oil trading? Since China now imports more oil than the US, it might become a reality.

The counter argument is that China has a huge debt bubble and a trillion or so in bad loans internally. True. China also has $3.3 trillion in currency reserves. This is why China jumped in to finance our debt in '08 and bleeds us out. They need those reserves to have value just long enough to gobble up hard assets. The problem with China's internal bad loan issue is that it is a black box. No one knows what the hell is there. Local governments have supposedly $1.7 trillion in loans piled up. These guys in 2001 at UM were right that loan resolution would fail as China has just rolled up bad '90s loans into their new bank system. Their land bubble is amazing, and the result of mainland Chinese having limited investment options. This is a problem, and one with little transparency. China is trying to change the situation by making Shanghai a major financial center with the goal of 2020 as the date of full realization. Still, I would be betting on the country that runs a trade and current account surplus, a homogeneous population and quick means of reforming or killing corrupt cronies. China is a nation aligned more with Russia's Putin who views the west as committing suicide, so they may learn from our mistakes.

I've blogged before on China's potential as the next hyperpower. I'm optimistic on their future. This will be a long process. It remains to be seen if the Chinese will want the reserve currency status or not. They may just want regional hegemony, a free hand in the western Pacific or just a place in the sun. Europe's economic and demographic crisis as well as the euro's disintegration will play to China's hand. The countries who do accumulate currency reserves will have a choice in the coming years. If China times it well, they can be Plan B for countries that are forced to lower or remove euro reserves but do not want to deal with Uncle Sam's games. Here's another secret: many countries have moron cousins running their investment or currency bureaucracy and consider the yuan as having nowhere to go but up. Many large Chinese goals are all planned to reach fruition between 2018-2020. It is an awfully dangerous time historically for a global power that is locked in an economic mutually assured destruction arrangement to be as fractured as America is in comparison to their partner China. With a gold backed or supported yuan, a debt bubble behind it, a new financial center and several years of international use of the yuan in trade agreements, China may just be too tempting of a country for others to buy into for financial security.

*Prediction of 2020 for the debt + economic issues to be resolved. Social + political issues will come after.


Cogitans Iuvenis said...

I am of a different opinion on China in the long run, but you do present some interesting arguments. And you are right, China is really a big black box. One thing is for sure, the next 8 years will be a very interesting, and potentially very dangerous.

peterike said...

China has plenty of unknowns and plenty of its own problems, but they are ruthless and nationalistic, as opposed to the U.S. which is weak willed and globalistic at the expense of nationalism. Who would you bet on?

On the other hand, all it would take is for the U.S. to switch to a nationalistic economic program (i.e. repatriate manufacturing) and China could collapse in short order. It only took ten years or so for us to get rid of our manufacturing. We could get it back in the same time frame.

Of course, the current elites in the U.S. will never do such a thing, but Allah willing the current elites will get defenestrated at some point and a nationalistic regime take their place (I can only see this happening via military coup).

Ultimately I think the U.S. will need to cede the Pacific to China, and so what? If we don't goad them into a war the way we did with Japan, they can have the stinking East for their playground. It's long past time that we rolled up the welcome mat and became fortress America again.