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The tightly controlled Chinese yuan will eventually supersede the dollar as the top international reserve currency, according to a new poll of institutional investors.
The survey of 200 institutional investors – 100 headquartered in mainland China and 100 outside of it – published by State Street and the Economist Intelligence Unit on Thursday found 53 percent of investors think the renminbi will surpass the U.S. dollar as the world’s major reserve currency.
Optimism was higher within China, where 62 percent said they saw a redback world on the horizon, compared with 43 percent outside China.
“As China’s economic influence grows, the global importance of the renminbi will become magnified. Indeed, while for decades it has been a ‘greenback world’, dominated by the U.S. dollar as the world’s primary reserve currency, many think a ‘redback world’, in which the renminbi enjoys premier status, is increasingly a possibility,” the report accompanying the survey said.
(Read more: Yuan takesanother step forward as a world currency)
This view was shared by European Central Bank Executive Board member Yves Mersch, who said on Wednesday that China’s yuan is gaining importance in international trade and investment and might ultimately challenge the U.S. dollar.
However, skeptics of yuan internationalization argued that the renminbi will never be liquid enough across all asset classes to serve as a viable reserve currency, and that people will not trust the renminbi as a store of value.
Despite being a closely-managed currency, the renminbi’s global clout has been rising steadily. By the end of 2013, the renminbi had become the second most used trade financing currency and ninth most used currency for payments globally.
Recent moves in the yuan have triggered speculation that the People’s Bank of China is getting ready to widen its trading band – which would be a step towards liberalizing the Chinese currency. The yuan is currently allowed to rise or fall by 1 percent in either direction from a level fixed against the dollar each day by the country’s central bank.
Ultimately, a greater role for the yuan would require China to liberalize its financial policies, including decreasing exchange-rate intervention, liberalizing interest rates and relaxing restrictions on capital flows.
Two-thirds of the respondents of the survey expect Beijing to complete its financial liberalization within ten years, with a majority expecting major reforms within five.
(Read more: Is China getting ready to widen the yuan’s band?)
Financial liberalization in the mainland began in earnest after 2009, with the government’s decision to allow cross-border trade settlement in renminbi, ease the process of listing offshore bonds and introduce the renminbi qualified institutional investors (RQFII) program.
The reforms, however, are still limited in scope, with strict quotas for how much currency can move across the border.
Last year, the government launched the Shanghai free-trade zone as a testing ground for financial reforms, including full yuan convertibility.
—By CNBC’s Ansuya Harjani. Follow her on Twitter @Ansuya_H
The last 7 days have seen the unstoppable ‘sure-thing’ one-way bet of the decade appreciation trend of the Chinese Yuan reverse. In fact, the 0.95% sell-off is the largest since 1994 (bigger than the post-Lehman move) suggesting there is clear evidence that the PBOC is intervening.
The fact that this is occurring with relatively stable liquidity rates (short-term repo remains low) further strengthens the case that China just entered the currency wars per se as SocGen notes, intending to discourage arbitrage inflows. For the Chinese authorities, who do not care about the level of their stock market (since ownership is so low), and specifically want to tame a real-estate bubble, thisintentional weakening is clearly aimed at trade – exports (and maintaining growth) as they transition through their reforms. The question is, what happens when the sure-thing carry-trade goes away?
BofA notes the puzzling divergence between Yuan fixings and short-term liquidity,
The turn of the Chinese New Year brought the People’s Bank of China (PBoC) back into action – it not only restarted repo operations to withdraw liquidity, it actually did it at a much higher rate. The 7d reverse repo rate at which the PBoC injects liquidity is 75bp higher than a year ago, a move considered by the market as a 75bp rate hike over the last year. The new 14d repo (liquidity withdrawal) rate is set at 3.8%, 105bp higher than the rate when 28d repo was last conducted on 6 June 2013. Based on a simple framework, this move is equivalent to another 35bp rate hike (Rate corridor, Chinese style, 18 February 2014).
The puzzle is that both money and bond markets nearly totally ignored such an operation. The 7d repo rate is now fixed nearly 200bp lower since 10 February. Such a massive liquidity improvement in the face of the PBoC’s liquidity withdrawal is puzzling, since by 10 February most of the cash used during Chinese New Year should have flowed back into the financial system already.
The FX market move also begs the question as to why liquidity improved over the last couple of weeks. Generally, the onshore repo rate rises as the RMB weakens against fixing; a normal development because FX outflow dries up liquidity. However, the move in February turned things upside down. Look at the sharp divergence between rates and FX
Which leaves 2 possible reasons for the divergence…
It is due to the seasonality of outflows, as this year could be made worse because the onshore rate was much higher before the Chinese New Year. As a result, banks might have borrowed more offshore, helping the RMB to appreciate. After the New Year, this flow reverses and pushes the RMB down. This explains why the CNY leads the CNH in spot selloff. It is also consistent with the large January FX purchase position of CNY466bn. The trouble with this explanation is that as the money flows out, the onshore rate should rise, not drop.
A more popular theory or suspicion puts the PBoC behind the move. As the PBoC buys more USD, it creates natural liquidity in the CNY, leading to much lower repo rates. This explanation is consistent with CNY leading the move, as CNY and CNH spots moved much more than forward, all suggesting a domestic investor-driven rather than foreign investor-driven endeavor. The trouble with this explanation is that the market will have difficulty proving it one way or the other without the central bank explicitly admitting it.
As SocGen notes, the latter makes more sense…
In just short seven days, the once unstoppable appreciation trend of the yuan is reversed. The USD/CNY spot has depreciated by 0.8% since 17 February and the USD/CNH has weakened by more than 1.1%. As for the causes, there is clear evidence of intervention from the People’s Bank of China. We think that the recent yuan move is intended to discourage arbitrage inflows. If short-term capital inflows abate, the depreciation will probably halt.
Ending the inexorable carry trade…
The yuan appreciated by nearly 3% against the greenback and 7% against in nominal effective exchange rate terms in 2013. Over the same period, China’s FX reserves added another $500bn, despite the repeated talk from officials that China has had enough reserves. These seemingly contradictory messages and signs, in our view, suggest that the PBoC never really wants too much yuan appreciation, especially if it is driven by short-term speculative capital inflows.
Which is crucial…
The yuan possesses the very two qualities of a carry trade currency: high onshore interest rates and a gradual but steady appreciation trend. The first quality is partly caused by the Fed’s easing policy and partly by the PBoC’s reluctance to ease domestic liquidity conditions out of concerns over debt risk. This condition is unlikely to weaken significantly in the near term. However, the PBoC is capable of altering the second condition and it seems that it is doing exactly so by reversing the appreciation trend and pushing up the volatility of the yuan.
If we are right about the reason behind the surprising deprecation of the yuan, what will follow next?
– Band-widening? Maybe, but as we have argued before, what matters is how the PBoC manages the currency. To make real difference, we think that the next step in yuan reform should be bolder: the PBoC should move from daily to weekly (or even monthly) setting of the reference rate, while at the same time widening the currency band.
– More depreciation? Probably not much more. Although the central bank does not like too much capital inflows, too much outflows will not be its choice either. The monthly FX position data are something to track for any change in the capital flow direction. A timelier indicator is the spread between CNH and CNY spot rate. If the offshore rate stays persistently weaker than the onshore one by a certain margin, that will be a sign of capital outflows. Then the PBoC will most likely choose to stabilise the yuan again.
The end-result is a concern:
Should the RMB weakening last a while longer, the cross border carry arbitrage flow which has been massive could reverse and lead to higher repo rates. Such a flattening force is a real threat, especially when the PBoC has shown no sign of lowering the repo rates in its operations.
But this certainly will not please the Japanese (trying to devalue and manufacture their own recovery) or any other beggar thy neighbor nation. Welcome to the Currency Wars China… (and we warned here, prepare for more carry unwind and a potential risk flare).
Potential asset deflation is a risk, as the carry trades diminish/unwind. Property prices are at risk – the collateral value for China’s financial systems. This is not a dire projection – it simply seeks to isolate the US QE as a key driver of China’s monetary policy and asset inflation, and highlights the magnitudes involved, and the transmission mechanism. Investors should not imbue stock-price movements and property price inflation in China with too much local flavor – this is mainly a US QE-driven story, in our view.
And lastly, as a bonus chart, we thought the correlation here was interesting…
Nouriel Roubini, Davos Speakers, Kyle Bass, Larry Edelson, Charles Nenner, James Dines, Jim Rogers, Marc Faber, Jim Rickards and Martin Armstrong Warn of Wider War
Well-known economist Nouriel Roubini tweeted from the gathering of the rich and powerful at Davos:
Many speakers compare 2014 to 1914 when WWI broke out & no one expected it. A black swan in the form of a war between China & Japan?
Both Abe and an influential Chinese analyst don’t rule out a military confrontation between China and Japan. Memories of 1914?
Kyle Bass writes:
Trillions of dollars of debts will be restructured and millions of financially prudent savers will lose large percentages of their real purchasing power at exactly the wrong time in their lives. Again, the world will not end, but the social fabric of the profligate nations will be stretched and in some cases torn. Sadly, looking back through economic history, all too often war is the manifestation of simple economic entropy played to its logical conclusion. We believe that war is an inevitable consequence of the current global economic situation.
Larry Edelson wrote an email to subscribers entitled “What the “Cycles of War” are saying for 2013″, which states:
Since the 1980s, I’ve been studying the so-called “cycles of war” — the natural rhythms that predispose societies to descend into chaos, into hatred, into civil and even international war.
I’m certainly not the first person to examine these very distinctive patterns in history. There have been many before me, notably, Raymond Wheeler, who published the most authoritative chronicle of war ever, covering a period of 2,600 years of data.
However, there are very few people who are willing to even discuss the issue right now. And based on what I’m seeing, the implications could be absolutely huge in 2013.
Former Goldman Sachs technical analyst Charles Nenner – who has made some big accurate calls, and counts major hedge funds, banks, brokerage houses, and high net worth individuals as clients – saysthere will be “a major war starting at the end of 2012 to 2013”, which will drive the Dow to 5,000.
Veteran investor adviser James Dines forecast a war is epochal as World Wars I and II, starting in the Middle East.
Billionaire investor Jim Rogers notes:
A continuation of bailouts in Europe could ultimately spark another world war, says international investor Jim Rogers.
“Add debt, the situation gets worse, and eventually it just collapses. Then everybody is looking for scapegoats. Politicians blame foreigners, and we’re in World War II or World War whatever.”
Marc Faber says that the American government will start new wars in response to the economic crisis:
- “The next thing the government will do to distract the attention of the people on bad economic conditions is they’ll start a war somewhere.”
We’re in the middle of a global currency war – i.e. a situation where nations all compete to devalue their currencies the most in order to boost exports. And Brazilian president-elect Rousseff said in 2010:
The last time there was a series of competitive devaluations … it ended in world war two.
Jim Rickards agrees:
Currency wars lead to trade wars, which often lead to hot wars. In 2009, Rickards participated in the Pentagon’s first-ever “financial” war games. While expressing confidence in America’s ability to defeat any other nation-state in battle, Rickards says the U.S. could get dragged into “asymmetric warfare,” if currency wars lead to rising inflation and global economic uncertainty.
As does Jim Rogers:
Trade wars always lead to wars.
Martin Armstrong wrote in August:
Our greatest problem is the bureaucracy wants a war. This will distract everyone from the NSA and justify what they have been doing. They need a distraction for the economic decline that is coming.
Armstrong argued last month that war plans against Syria are really about debt and spending:
The Syrian mess seems to have people lining up on Capital Hill when sources there say the phone calls coming in are overwhelmingly against any action. The politicians are ignoring the people entirely. This suggests there is indeed a secret agenda to achieve a goal outside the discussion box. That is most like the debt problem and a war is necessary to relief the pressure to curtail spending.
In addition, historians say that the risk of world war is rising because the U.S. feels threatened by a rising China … and the U.S. government considers economic rivalry to be a basis for war
Moreover, former Federal Reserve chairman Alan Greenspan said that the Iraq war was really about oil, and former Treasury Secretary Paul O’Neill says that Bush planned the Iraq war before 9/11. And see this and this. If that war was for petroleum, other oil-rich countries might be invaded as well.
And the American policy of using the military to contain China’s growing economic influence – and of considering economic rivalry to be a basis for war – are creating a tinderbox.
Finally, multi-billionaire investor Hugo Salinas Price says:
What happened to [Libya’s] Mr. Gaddafi, many speculate the real reason he was ousted was that he was planning an all-African currency for conducting trade. The same thing happened to him that happened to Saddam because the US doesn’t want any solid competing currency out there vs the dollar. You know Gaddafi was talking about a golddinar.
Indeed, senior CNBC editor John Carney noted:
Is this the first time a revolutionary group has created a central bank while it is still in the midst of fighting the entrenched political power? It certainly seems to indicate how extraordinarily powerful central bankers have become in our era.
This suggests we have a bit more than a ragtag bunch of rebels running around and that there are some pretty sophisticated influences. “I have never before heard of a central bank being created in just a matter of weeks out of a popular uprising,” Wenzel writes.
Nothing lasts forever (as we’ve shown before) – except perhaps gold as a store of value it would appear.
Central banks around the world are increasingly diversifying their currency reserves away from the US Dollar. Even as overall holdings soar to a record $11.4 trillion, the US Dollar accounted for 61.44% (down from well over 65% at the peak of the crisis in 2008). With China outspokenly concerned at the US Dollar’s future status, we suspect this will only become more ‘diversified’.
- Bundesbank Warns China’s Currency “On Its Way To Becoming Global Reserve Currency” (sgtreport.com)
- CENTRAL BANKERS Announce PLANS FOR CHINESE YUAN, REVEAL YUAN IS ‘WELL ON IT’S WAY’ To Becoming ‘GLOBAL RESERVE CURRENCY’, DISPOSING USD (secretsofthefed.com)