The Fed's QE policies of recent years have, for all intents and purposes told the world that “the dollar is our currency and your problem.”
And, in recent years, the dollar has been a genuine problem for a number of emerging countries. Indeed, if nothing else, the Lehman Brothers bust revealed the extent to which almost all of the trade (and project financing, and private bank lending, etc…) between emerging markets still takes place in dollars. This means that emerging market nations must either first earn dollars, or find someone to lend dollars to them, before expanding their trade and capital spending. It also means that, if U.S. banks are mismanaged, emerging markets tend to fall apart as companies there can no longer obtain financing for trade, investment projects, etc...
This was the main lesson that most emerging market policymakers learned in 2008. Until then, having 100% of one's trade denominated in dollars did not seem awkward. But once the Lehman bust showed to the world that American bankers were no smarter than anyone else's and worse, that American regulators were also no better than any other countries’, then financing every trade and every investment in dollars rapidly shifted from being the “easy thing to do” to a “problem that needed to be addressed”. All of a sudden, it became obvious that depending on the dollar made no sense if the U.S. banking system was badly managed and badly regulated. The scales fell from the eyes of the emerging markets' policymakers. And chief among the countries looking to make a shift was China which, by 2008, had become the number one, or at worst number two trading partner for almost any emerging market, importing commodities from Latin America, Africa, the Middle East, Russia or Southeast Asia and exporting manufactured goods everywhere around the world.
With Lehman and AIG hitting the skids, trade finance just dried up, and China’s exports fell -25% YoY:
Now the fact that the U.S., or Europe, would import less as they entered into a recession was understandable enough. But really what stung most was that China’s emerging market trading partners also cancelled orders and, as a result, some 25mn migrant workers lost their jobs almost overnight.
Following this traumatic event, and the change in the perception of US stability, China went around the world and invited the likes of Brazil, Indonesia, South Africa, Turkey and Korea to shift some of their China trade away from the dollar and into renminbi. China started doing this in 2011 and, as we see it, the renminbi’s attempt to become a trading currency is potentially one of the most important financial developments. Yet no one seems to care.
For the likes of Brazil, Turkey or South Africa to start trading in renminbi means that these countries' central banks will need to keep some of their reserves in renminbi. Which, in turn, means that China needs to offer assets for these central banks to buy. This simple reality has pushed China to create the offshore renminbi bond market in Hong Kong, the “dim sum” bond market. China’s invitation to other countries to start trading more in renminbi also explains why, over the past two years, the PBoC has gone around the world and signed swap agreements with the central banks of Brazil, Korea, Turkey, Australia, Argentina and countless others. In essence, China has told her emerging market trading partners: “Let’s move our trade to renminbi and if you don’t have any, you can come borrow some on my HK dim sum bond market, or alternatively, we will just lend some to you directly through our central bank.”
Given the increasing risk that a U.S. with a structurally improving trade balance (thanks to falling energy imports) will send ever fewer dollars abroad, China’s attempt to mitigate its dependency on the dollar could not be better timed. Of course, these efforts can only bear fruit if both the renminbi bond market and the renminbi exchange rate prove to be stable –Â in essence, if the renminbi is seen as offering a reasonable alternative to the dollar; if the renminbi manages to transform itself into the deutschemark of emerging markets.
Which brings us to the global bond market meltdown that followed the Fed’s announcement of a possible tapering of U.S. treasury purchases –Â the Spring 2013 "taper tantrum." Following Ben Bernanke’s May 2013 declarations, emerging and OECD government bond markets sold off aggressively to the point where, in the second quarter of 2013, renminbi bonds were the only bonds globally to offer investors positive returns! Like the hounds in Silver Blaze, the renminbi bond market has been the dog that did not bark; and just as Sherlock Holmes was quick to deduce an important message from the dogs’ silence, perhaps we should listen to the sound of the renminbi bond markets stability?
Indeed, in the face of weak Asian currencies, underwhelming Chinese economic data and disappointing global industrial and consumption numbers during 2013 (weak U.S. ISM, weak EU retail sales, etc.) most would likely have expected Chinese bonds, or the renminbi, to fare poorly. Yet, renminbi bonds have been the new shelter in the storm; a reality which draws two possible explanations:
continue reading: http://www.mauldineconomics.com/outsidethebox/the-importance-of-rmb-internationalization
