The Rise of the Yuan

by Kevin D. Freeman on November 12, 2011

expandThe cover story of BARRON’S this week would have been considered unthinkable by most experts just a couple of years ago. Yet, it is precisely in line with our thinking and echoes the findings of our earlier research for DoD outlined as Phase Three. The importance of this article is that the reality is now beginning to sink-in to the investment community.

To understand this importance, you have to recall the mainstream view from not long ago. The prevailing thinking was that the Chinese economy was so dependent on exports to the United States and Europe that it would never do anything to harm Western economic growth. We argued that once the Chinese determined it in their interests to undermine the dollar’s reserve status, they would do so with potentially dire consequences. We documented our beliefs with direct quotes from official Party statements and the military doctrine articulated in Unrestricted Warfare. The mainstream directly challenged our assertions at various points, always reverting to a naive belief that the status quo of a dominant U.S. dollar would remain for a half century at the least.

Of course, we were among the very first to identify that the U.S. Treasury debt would lose its AAA status. They told us we were wrong until it happened in August. Immediately, the economists pointed to the fact that the debt downgrade actually strengthened Treasury prices. Of course, this strengthening only happened because the dollar remained the reserve currency. Once that status is removed, the United States will be in a similar position to Italy and Greece. The BARRON’S cover story does a decent job of explaining why the dollar’s unique status will be challenged much sooner than any were expecting:

By the end of the decade, China wants to establish the yuan as a reserve currency that could someday challenge the almighty buck.

The U.S. dollar is the currency of the world, but that dominance could begin to erode if China has its way. It won’t happen right away, but by the end of the decade, the yuan could join the buck and the euro as one of the world’s reserve, or anchor, currencies.

Nearly three of every four of our hundred-dollar bills circulate abroad. Oil, copper and almost every other internationally traded commodity is denominated in dollars. The vaults at foreign banks and governments are stuffed with greenbacks. Sixty percent of the planet’s foreign-exchange reserves are made up of U.S. dollars, far more than 27% for the euro and 4% for the yen.

But with the dollar depreciating and the euro imploding, China is seizing the opportunity to encourage other countries to use its currency as a medium for trading and investments, as well as a store of value. It’s a big leap forward since the yuan — also called renminbi, which translates literally into “the people’s money” — is tightly controlled and isn’t freely convertible into other currencies.

In recent years, China has stepped up an ambitious plan to increase the circulation of yuan outside the mainland and persuade trading partners to use it to invoice or settle transactions. And it is aggressively building a market for yuan-denominated debt. In the past year, McDonald’s (ticker: MCD) as well as Caterpillar (CAT) and Unilever (UN) have all raised money by issuing yuan-denominated debt in Hong Kong. And that’s just a start.

If all goes according to plan, the yuan could become one of the world’s reserve currencies as soon as 2015 …

Our biggest creditor has grown uncomfortable with America’s wanton indebtedness, not to mention the threats made during this summer’s debt-ceiling debacle to default on our obligations. It’s no coincidence that China has grown more vocal about its ambition to establish its own anchor currency, and president Hu Jintao has repeatedly called a dollar-dominated currency regime “a product of the past.”

“The U.S. government has been able to finance our deficit for less than it might cost because we manage to sell lots of Treasuries,” Eichengreen adds. “But if foreigners become less willing to buy, we’ll soon lose that ability.” Americans may even have to starting saving more to finance our own economic growth. “Relying on the savings of foreigners willing to lend to us at favorable rates isn’t going to cut it anymore,” Roach says. “The Chinese have made it clear that those days are numbered.”

The BARRON’S article is a major piece and well worth the price of picking it up on the newsstand or getting a subscription. We have just provided a few key excerpts. But the point is real. While it once was in the Chinese interest to preserve the dollar’s unique status as primary reserve currency, that time has passed. The Chinese understand that the U.S. debt situation precludes us from continuing to binge on their products. To survive economically, they have to adapt and use their economic weapons even at our expense.

As we have noted previously (Which Chinese? ), there are several key factions in China. There is the business community which has long supported a weak yuan to enhance exports. There is the ruling Communist Party which has put forward five-year plans for global dominance. And, there is the PLA (People’s Liberation Army) which has promoted Unrestricted Warfare. For the first time in decades, the interests of all three are beginning to align against the dollar. This is VERY significant and we need to understand it before it is too late to respond.

The reality is that the Chinese understand that we are in the midst of a global economic war. Hopefully our policymakers will begin to realize this.

Here are some of our earlier posts on the subject for your review:

Yuan Likely Convertible in Five Years

China’s Yuan To Challenge Dollar Much Sooner Than Previously Expected

They said it wouldn’t happen….dollar to lose reserve status

The War Began with a Press Release….

The Chinese Take a Long Term View; Evaluating Their 5YP

China Ready for Economic War (analysis)

China Ready for Economic War (the article)

All posts Copyright (c) 2011 Kevin Freeman, All Rights Reserved

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