by Aaron Krowne
There has been a lot of well-meaning talk about the “threat” of China dumping the dollar, with precious little discussion of potential mechanisms.
A ZeroHedge piece that just came out got me thinking that China is actually well underway on its path to explicitly driving the stake into the heart of the dollar once and for all (incidentially, this makes a nice follow-on to my recent article about China’s ability to “dump” the dollar based on hard asset holdings). It is clear now they really are going down a well-defined path here, that shows it is only a matter of time until we arrive at wholesale regime change for the dollar-dominated international trade system.
The main insight in the article is that China is taking new steps to provide for settlement of trade in Yuan instead of dollars:
The Chinese central bank surprised with a spectacular announcement: The would-be superpower wants to handle their entire future foreign trade in yuan, not in dollars. Beijing shakes America’s claim to represent the key currency – with serious consequences for the U.S..
Previously, China also announced that bilateral trades with Russia and Malaysia will begin to be conducted with the yuan and the ruble and ringgit, respectively.
Other moves on the part of China to internationalize its currency include allowing foreign companies to issue yuan-denominated bonds and relaxing rules for foreign financial institutions to access the yuan.
Over the past two years, they had begun doing this at first with select trading partners. Then, in the last few months they began establishing the general ability to do this via the normal banking system (as in, allowing for holding Yuan in banks outside of China).
Those who are saying that China is “stuck” with the dollar are now apparently more sure of this than China is. If China is “stuck”, it is certainly not acting like it. And heaven forbid they create exactly the outcome they want to bring about by resolutely taking those first few steps of a “journey of 1000 miles”, nay-sayers be damned.
When you think about it, it makes little sense that everyone (especially the Chinese) should by default hold dollars, when China and not the US is the “company store” the world goes to for most of its goods. Basically, the US has (till now) had the geopolitical influence to demand its own worthless IOUs be accepted by that store. But now the vendor realizes that if he decides not to accept them, the customer will not have anywhere else to go, so it is the vendor (i.e., the one providing the real stuff) that can demand the terms.
China has clearly had that realization, and is beginning to prepare for this future by setting up an infrastructure so major trading partners and individuals can settle trade in Yuan, if they want to. Customers (especially BRIC members) that don’t want to be exposed to the dollar will choose this now, but few others will.
This is a distinct phase: start making Yuan trading available; expand it, but it will remain “optional”.
However, a second phase will no doubt follow where everyone buying from China will be forced to use the Yuan. As I pointed out in the company store analogy, it makes zero sense to use the customer’s currency, rather than the store’s “house currency”. The customer is just as well able to sell its own currency (dollars) and buy the store’s (Yuan) — provided, of course, the facilities to do so exist. Once they do, there will be little excuse not to use them.
There will be no practical limitation from buying Yuan and selling dollars to do so, and it will be compulsory as long as the world is buying $40-60B of Chinese goods, and returning nothing of value, on a monthly basis.
I can’t imagine the onset of that phase will be any good for the dollar.
To look at it in a broader historical perspective, the phases can be seen as this:
- China decides to industrialize and begin opening; needs the help of the US, the pre-eminent advanced Western client. Has virtually no choice but to accept dollars, but also no reason to worry about investing them back in the US. Pegs the Yuan low to provide a “discount” for all goods purchased, as this is its only real selling point (no mature industry is present; it all has to be built from scratch).
(The US also has the slight problem that it has taken its currency off the gold standard, and so no one really “wants” the dollar. Who better to take it, no questions asked, than a new economic “client” state?)
- China becomes well-developed (supply-side wise), and in fact, the largest nation with a full base of industry (to the US’s detriment). Still accepts dollars, in fact more than it’d like, as the US isn’t making much in the way of goods anymore (the built-in discount for Chinese goods proved impossible to compete with). By the end of this phase, the US has thoroughly discredited its capital markets by allowing them to become rife with fraud and bubbles, and its government financing has become a huge Ponzi scheme.
- China begins implementing Yuan settlement facilities, and some Yuan banking. We are in this phase now. Utilization of the facilities is optional, and only “US haterz” participate on a large scale, mostly out of principle. The dollar is still not “threatened” in the near term, as there is still far too little “depth” in the Yuan international market.Also in this phase (discussed in my previous article), China is engaging in many off-market transactions to secure hard assets, without “selling” dollars in any meaningful volume (interesting question: why would they do this if they didn’t expect the dollar’s value to fall hard in the not-too-distant future?)
- China’s realization that they are the vendor and can demand the manner of payment comes to full fruition, as Yuan settlement becomes mandatory. Yuan banking and large-scale Yuan markets have been set up for Chinese global trade in its totality.
An interesting question is the timing of phase 4. Phase 1 was about 20 years. Phase 2 lasted about 10. Will the time scale continue to compress? I suspect so. If we are 2 years into phase 3, then perhaps it will last 3 more years, for 5 total. That would mean in 2013/14, Yuan trade/capital facilities will reach their full “breadth” (though not depth). Then over about 2-3 years, the “switch over” would occur, and the world would be forced off the dollar, for China trade purposes at least (other purposes would follow due to the massive volume involved). That puts us at about 2016/17 for “dollar drop dead” date.
So perhaps this is one more “five year plan” — and one the US really needs to pay special attention to.
But as for timing, who really knows. What I am much more confident about is the course of the path.