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SOVEREIGN MAN

When will the renminbi overtake the dollar?

January 6, 2011
Santiago, Chile

Without a doubt, the existing global financial system depends on the widespread use of fiat currencies issued by insolvent governments.  The wealth of the world’s large financial institutions requires that there be currencies with sufficient size and circulation to absorb massive capital flows.

The current system is based primarily on the dollar; with a $14 trillion economy, the United States was for years the only country in the world with a sufficient money supply and financial infrastructure to take in the preponderance of the world’s wealth.

It is for this reason commercial loans, commodities contracts, international reserves, and cross border settlements have traditionally been denominated in US dollars.

Competing reserve currencies arose with the advent of the euro and Japan’s post-war rise; while the dollar has continued to remain dominant, these three are the only currencies which have the necessary supply and credit rating.

With trillions of dollars floating around the global financial system, managers are constantly making capital allocation decisions, moving funds in and out of various instruments.  The reserve currencies play a big role in this because unallocated capital is frequently parked in their bond markets.

For example, large corporations or banks that are sitting on billions of dollars in cash typically purchase short-term US or European government bonds because the low default risk.

The dollar, euro, and yen have bond markets of such size that getting liquid is never a problem, even for billions of dollars.  There is always a market for treasury securities, hence they are considered ‘cash equivalents’.

You couldn’t do the same thing in the Kingdom of Bhutan with its tiny $3.5 billion economy. If you tried to move $100 million into Bhutan, its currency (the ngultrum) would spike. In the US, Europe, and Japan, $100 million barely registers a blip.

Over the last few years, though, the confidence has begun to fade quickly, and the reserve currency issuing governments are starting to be viewed with increasing skepticism.

The thing that’s missing right now is an acceptable alternative. There’s really nothing out there in large enough scale to withstand massive capital flows, and as I have written before, the game is now one of judging the ‘least worst’ of these three major currencies.

In what seems to be a 6-month cycle, the dollar and euro have been jockeying for the ‘worst of the worst’ title; markets focus on Greek woes for a few months, then turn their attention back to California and Obamanomics.

With Bernanke’s “100% certainty” and nonsensical economic numbers coming out of the America’s Ministry of Truth (Newspeak: USMiniTruth), we seem to be back in a period where the markets are more concerned with Europe. I think that Japan will be called to the carpet before too long as well.

As such, in an almost ritualistic cycle, financial markets are shifting funds around these currencies… the analogy I like to think of is like a series of buckets.

Imagine three buckets and an increasing volume of water. Capital allocators are essentially dumping the contents of one pail into another– from the dollar bucket into the euro and yen bucket, and from the euro bucket back into the dollar bucket.

Each time this happens, though, a little bit of water spills out into smaller buckets– gold, silver, Switzerland, Norway, Canada, Chile, Australia, etc.

All throughout, central bankers are standing there keeping the spigot at full blast, pumping more water into the system while bankers desperately try to find the least leaky balance.

What’s required is a new bucket that bankers view as strong, sturdy, and large enough to handle the volume. The most likely candidate is the Chinese renminbi… but not yet.

China’s economy is set to be the largest in the world in a matter of years, and it has the money supply to match. While its economic and monetary fundamentals are far, far from perfect, China is arguably in a much better financial position than the west.

It’s going to take several years for the renminbi to overtake the dollar, euro, and yen as a serious contender for the world’s main reserve currency… but it can happen. The major roadblock is that China’s renminbi is not free-floating– the government has imposed severe exchange controls.

I’ve written before that we are seeing the early signs of relaxing controls. China doesn’t do anything overnight, and I think there is a long-term plan in the works.

We have already seen China agree with other sovereign nations to introduce currency swap arrangements, so there are now several countries holding renminbi.  Furthermore, the Hong Kong gold exchange recently announced its plans to launch a new gold contract denominated in renminbi.

To be clear, China already has its own gold exchange, but having one in Hong Kong opens up renminbi-denominated gold contracts to the entire world since Hong Kong has no exchange controls.

On that note, the mainland authorized Hong Kong’s banks to establish cross-border settlement accounts in renminbi last year, effectively providing a way for people to open a renminbi bank account. In fact, we have one.

Each of these measures to reduce exchange controls is one step closer to the renminbi being introduced as a global reserve currency.

Perhaps the most obvious step, though, came in just the last few days. Beijing has already allowed several multinational companies like McDonald’s and Caterpillar to issue renminbi denominated bonds.  Now the World Bank, that unfortunate staple of the financial system, is issuing its own two-year renminbi bond.

This is a big deal… and I think that we’re going to continue to see bigger and bigger steps like this taken throughout 2011 and the coming years.

China’s government has been very clear that by 2020, it wants Shanghai to be a leading global financial center… and Chinese policymakers know that for Shanghai to be a financial center, the renminbi must be freely convertible.

Make no mistake, my friend, the deadline has been set… and if you haven’t started making decisions to preserve your capital, I strongly urge you to start now. More to follow.

Our goal is simple: To help you achieve personal liberty and financial prosperity no matter what happens.

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About the author: Simon Black is an international investor, entrepreneur, permanent traveler, free man, and founder of Sovereign Man. His free daily e-letter and crash course is about using the experiences from his life and travels to help you achieve more freedom.

Comments on this entry are closed.

  • Aeonioshaplo

    I think your explanation is backwards, if I understood Mises correctly. Rather, the fact that the US became the primary ‘reserve currency’ for the world’s tax farms is because the US had an enormous amount of capital to back up the value of the dollar, plus a relatively long history of solvency.

    Rather, the vast amount of capital that the US once sported allowed its economy to withstand a great deal of inflation without suffering a currency extinction. However, inflation always destroys capital like a black hole, and the US has inflated most of its capital away, plus a significant amount of foreign capital imported by exporting their inflation. The 2008 crash was a pretty dramatic indicator of the capital evaporation which took place during the Bush regime, but the current policy is much worse since it both covers up the embarrassing lack of capital and accelerates the evaporation of remaining capital.

    What does this mean for the Renminbi? Well, while China may have been recently established as an economic power by the grace of foreign capitalists, their policy towards virtually everything important economically has been backwards since then. Their own inflation, coupled with increasing government supported union strangulation can only lead to an inevitable crash of the Chinese economy, probably following the collapse of the EU. Given the history of such economic crashes, I expect China to experience their first major fail some time before 2030.

    If they do open up their currency for exchange, and if the renminbi does gain popularity as a reserve currency, this will put China in a position to ruin not only their own economy, which will fall last, but also the economies of all of their close trading partners, who will be sucked dry of capital by importing overvalued chinese inflationary money.

    Capital always flows towards the source of inflation (and businesses who first spend inflationary money), first from other industries in a country into those favored by the government, then, if the currency is strong enough, from other countries into the inflation exporting country, and the capital is always readily destroyed, either by direct government waste or by the inevitable increase in speculative failures caused by excessive currency-borne price changes.

    Yes, the renminbi will probably slay the dollar soon. No, it won’t last, nor will the current level of economic development worldwide if the major capital owning countries continue to escalate their insane destructive socialist policies. Today’s lesson: Always do your accounting calculations in terms of gold.

    • Mark92365

      Are you telling me the world is going to trust a bunch of Communists to make good on anything? talk about govt. control and interference. I’m not so sure that America will be a third world country, we have always been the last bastogne of freedom, it isn’t going to be China, just my humble opinion

    • Imperialadrian

      well, you many already know this, that Europe is already indebted to the EU. I was ecently in Europe, and the people are of course angry that they were suppressed to take the Euro. The Euro is not working, only for the Bankers, and they are artificially holding up the Euro. Look clearly at what has happened there already, there is no logical reason why the euro is at its current rate, its fake, fake, and more fake, being controlled by the Bankers, the Central Bank of Europe.

  • Jon

    Aeonioshaplo, The creation of the Fed and Congress’ declaring the government bankrupt goes back decades, is well documented in public law, and go hand in hand. The creation of the federal reserve note, the confiscation of gold, why the Fed refuses a complete audit…?

  • http://www.future-of-anti-aging.com Matthew

    As a close follower of Doug Casey and others, I firmly believe the global economic climate will drastically change over the next few decades.

    The Chinese are economically savvy and will take any and all actions to protect its wealth. Bernanke and team will continue to debase the US currency. The Chinese hold trillions of dollars.

    I highly doubt they will just sit back and let those holdings dwindle into thin air. They will buy commodities as fast as they can preserving and building real wealth. What is the US doing? Printing like there is no tomorrow. Whose side should you be on?

  • Swamichampak

    as per usual lotsa verbosity but Where’s the BEEF ?

    the headline is interducing the worlds next leeding curency [or some such headling ] – much reading later -a slight clue emerges-about the Renminbi & still no BEEF just BAFFLEGARB = overcomplicating simple concepts [ verbal/mental volley ball what ever happened to K.I.S ? Keep it Simple ?

    • Imperialadrian

      you won’t see the Beef until it is in your mouth. That is how china works.

  • Doctor Frank Wiseburn

    Your article never did name the next world currency, why didn’t you have enough back bone to absolutly speciiiiific China as the next worl reserve currency. I am very disappointed that you were not willing to take an exact position on this matter. Sincerely, Doctor Frank Wiseburn

    • ZGackowski

      Dear Doctor,

      You simply overlooked the title. The exact postion is for the too fast readers hidden in the title.

      Another Ph.D.

  • Ilyan Thomas

    Many Chinese have read Marx. THey understand how to use Capitalism to get Rich. They also have a national policy that avoids the internal contradiction in Marxism as well as properly used Keynesianism avoids the internal contradiction in Capitalism. Pity about the stupid tax dodging Capitalists who destroy the Lifeblood of Capitalism with inflation.

  • techman

    Having lived in China for 10 years and gained the trust of the local officials and business people, I find the idea of China’s RMB as the world standard a terrifying prospect and so do my friends in China.

    China manipulates their currency to such a degree that it is unreliable as a standard, taxes are collected according to your relationship with the tax bureau personnel , rules and policies are randomly enacted and randomly enforced, again, according to your relationship with officials.

    Now take a look at China’s control of strategic minerals and their in progress acquisition of critical food resources to achieve the same thing with the world food supplies. Does one really have to imagine China in control of the world’s monetary markets? To do so would be placing your wallet and credit cards in the hands of a smiling mafioso!

    • taxee

      Kind of like what we’re becoming here in the USA!

    • http://www.kristinlow.com Kristin Low

      Exactly. And it’s a testament to just how f*cked up the world financial system has become, that this is now our best hope.

      The renminbi ain’t perfect. But it’s less homely than every other girl at this party.

  • Larry

    Gentlemen,
    Maybe the best question is when will the BIS become the FED to the world and create and issue the Bancor as a currency for the world. We need one currency, and will eventully have to have one, why not now?

    • Mr. Magniloquent

      We don’t need the Bancor. Curing the disease of a centrally planned fiat currency with the same by another name–yet even more detached from markets is insane.

      There already is an international currency. It’s been that way for eons.

    • Imperialadrian

      I think that first you need to see who the FED really is. Next sep is to abolish the FED, I thinkthat you can assure that the dollar will remain the worlds Currency if our own Government goes back to the US dollar being backed by Gold, not fiat money. Of course a whole new dollar must be printed, and all ofthe old ones collected and verified. Only those verified can exchange them for the new ones.

  • http://twitter.com/JeffSwaney Jeff Swaney

    Is China going to replace the US as the next “world banker”?

    • Veritabletruth

      We are not likely to have a’ global anything’ in the future,, IMO…the US came out of a different time and place, regardless of some parallels with rome and hitler, as others have observed….
      Technology, globalization, post colonial materialistic capitalism…etc…the future will not be ‘dominated’ by one nation. it will be regionally dominated by one or two countries….with relative economic and political power. This is not wishful thinking on my part-it’s how I see things unfolding.

      Its funny to me to hear SM and others comment that one country will simply ‘take over’ the role of another country, as though it’s a position in a company. Although it may be similar,it is not. Dynamic, evolving,organic….many variables and factors create the climate at any given time. The western powers created the system and structure of the current system-it’s not really possible for a country outside of this to simple take over-this is akin to someone wearing last year’s designer clothes at a discount, and somehow thinking they are now in that demographic/class. Basically, the US is not going to swith roles with 3rd world bannana republics,or just be on ‘pause’ with nothing happening. Neither is europe, or hte UK, etc. I don’t know-=and I don’t think any of us truly do-it’s all speculative at the core, regardless of how much you think you know about investments, banking, economic/political theory, etc-we don’t know what absolute direction the US or european countries wil take.
      What new developments are ocurring?

      I look at things like charter and homeschool movements, alternative education, telecommuting, creative communities, local currencies, etc and I find it interesting to consider what micro cultures may find themselves doing in a decade or to or three.

      simply b/c china and many 3rd word countries now have buying power to have their own walmarts: This is the considered major evidence that they will be ‘global superpowers’? B/C the have created a mass of consumers? bwa ha ha ha….
      Perhaps according to that measurement, they re going to be ‘#1′-but that’s a very insular way of looking at the world. In any case, #1 does not mean what it used to mean. We’re not in kansas anymore, toto…time will tell.

      • http://www.kristinlow.com Kristin Low

        That’s an interesting and considered perspective, though I find myslef disagreeing.

        Is it all a “western” system? Sure – it has its origins in European and north American political systems. But that does not for a second rule out “non-western” (I hate the east vs west dichotomy – it’s not real) actors from competing in that same system and excelling to the point of overtaking every other player. Remember Japan? Played the game great. Too great. Look at them now.

        Debt is the underlying currency here. The money is, in so many ways, incidental. And so it follows that whoever has the capacity to absorb the largest amounts of debt, with the least affect to that debt’s value will be the winner.

        Yes, the system is broken – and badly. But it’s not crashing down this weekend, or probably even the next. In time there will be a recknoning, but not before the renminbi has it’s time in the sun as the final piece of land above the high tide mark.

        It really comes down to this: whoever has the largest bucket, with the least holes, is going to “win.” Currency flies to the least volatile refuge every single time.

        East, West – or any other imagined category you’d care to name has little to no impact whatsoever.

    • Imperialadrian

      The problem is that a group of people/Bankers want complete control over the world. Greed, and more greed is the culprit just like the Enron CEO deal, and our own Government is the Template for others to follow, when will it end? Never, because there will always be another one to replace to old one, its like voteing for the lesser of the two evils. Transparancy? Does not exist. All the Banks cheat on their reports,especially the European ones, seling stock that they dont own, the world has become so corrupt, there is no imediate answer to the madnes. any answer will take time to develope , just like it took time to crash. But one thing is for sure, that you are not going to fix the U.S. ‘s problem of debt by buying products from China, our greatest debt holder. it’s all a long term plan that China has applied more than 50 years ago to crumble the United STates, and its working well, so stop buying Chinese products, try your best to buy only U.S. made products. I know that presents another problem, our own Companies have all gone to China, our of greed, now our own Economy is failing because of it. Mind you, there always a RE-action to every Action.

  • tradingfool

    So buying the CYB (Yuan ETF) would be a good hedge against the falling dollar

  • Plato

    What will happen to the Renminbi and, in turn, the entire Chinese economy when its largest outlet for all its goods, The U.S., goes ‘bankrupt’? If the U.S. tanks, as everyone predicts, what world economy, and its associated currency, will be immune from the fallout? Only gold/silver will remain.

    • Ned11

      What will happen to the Australian dollar when the US dollar
      breaks up? Edward

  • Spartacuss

    No nation or group of nations will be able to stop fiat currency debasement. The reason is simple: too much existing debt.

    We need a stable currency. In order to do that debt will have to be repudiated. Lot’s of luck; the thing will crash first, big time. Hang on to your precious metals as the time of reckoning here is close at hand.

  • Mlhooker

    IF WE PUT A SACRED SYMBOL ON THE DOLLAR BILLS AND COINS,
    WITH “UNDER GOD” – MEANS ASKING HIM TO TAKE OIVER
    THE WORLD’S MINEY SYSTEM AND ITS PROBLEMS, WOULD HE
    AGREE?

  • Corioa

    Thanks for the tip. It’s part of magical chairs to siphon money from the big many to the monied few. We stay ahead by staying informed. Now I have to go back to the economy and get some money to invest!

  • http://twitter.com/petert3001 petert3001

    inter4esting new currency intorduced by China

  • Wercains

    Go ahead and trust the Chinese Government with your money. That’s smart like moving to South America and trusting those governments with your life.

    • Lodewyk

      On first reading I read South Africa instead of South America, but it boils down to the same!

    • http://www.kristinlow.com Kristin Low

      It’s more about spreading your eggs across several baskets – not just swapping them all for another, completely different basket.

      I like the attitude – keep it up. As long as there’s people like yourself around, South America – indeed every other hidden-gem around the world, will remain our ow little sectret, to enjoy and prosper in.

  • manoverboard

    I’m currently living in China, and they are becoming more and more Western. They are copying all our ideas and innovations because they have none of there own. The U.S and other Western countries have more experience in financial matters than China.

    • Imperialadrian

      Well people, there it is, coming directly from the horse’s mouth as we say.

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