China’s currency, the yuan, is a step closer to achieving its aim of dominating global finance. The latest move saw the London Metal Exchange (LME) give the yuan, or renminbi, a leg up. It announced the yuan is to become accepted as collateral on LME’s trading platform.
This development, as dry as it might sound, is more important than it first appears.
The LME is a rather big deal. It’s the global epicentre for industrial metals trading, handling most transactions. In 2014, the exchange traded $15 trillion worth of metals. Including the yuan as collateral is a big vote of confidence in the Chinese currency.
But this decision was a long time coming. China, as every Australian knows, plays a significant role in global commodity trade. Trevor Spanner, CEO of LME’s clearing house explains:
‘In the commodities area, it makes absolute sense to start providing renminbi-denominated services. The renminbi is on its way to becoming one of the world’s most widely used currencies’.
The evidence is mounting too.
A recent Bank of England survey noted that yuan trade increased by 25% in London between October 2014 and April 2015. Meanwhile, the use of other currencies dropped by 8% over the same period. The yuan recently became the fifth most used currency in international trade. That was up from seventh just a year ago.
What’s even more interesting about LME’s decision is that, currently, they accept only four other currencies as collateral. These include the US dollar, the euro, the pound sterling, and the Japanese yen.
This is important because it gives us a clue as to what’s coming. What do I mean by this? Well, those four currencies are currently the gold standard in global trade. They also happen to be the same currencies that make up the IMF’s Special Drawing Rights (SDRs).
SDRs, if you’re not familiar, is essentially a basket of currencies. In other words, it’s a supplementary foreign exchange asset that the IMF controls. The value of the SDRs is based on a combination of these four currencies.
China has its sights set on joining this basket of currencies. And it’s long believed that it’ll do just that in due course. The IMF indicated it’s only a matter of time before the yuan is accepted into the SDR.
Once it does, it’ll give the yuan major credibility in global finance. We’re going to see international reserves of the yuan rise exponentially. Simply put, it’ll liberalise China’s capital accounts. That, in turn, will open up China’s financial services to the rest of world.
Stock market troubles no barrier to yuan’s rise
China’s current stock market correction raises doubts about the yuan’s future. There are fears in some quarters that government intervention on stock markets is harmful to its prospects.
The truth is that these market events should have little bearing on the yuan’s ascendency. Chinese stock markets only mildly influence the wider economy. That’s because the share market isn’t a critical source of funding for Chinese companies as yet. As long as that’s the case, its impact on the economy will remain minimal.
In any case, we’re past the point of no return. China isn’t going to implode overnight, regardless of how its markets fare. The yuan simply has too much momentum behind it.
If anything, slowing global economic growth is a boon to the yuan. That’s because China’s share of the global economy continues to grow in contrast to other economies.
China to use investment banks to lift the yuan
Asia is primed to become the investment capital of the 21st century. It’s expected that over 60% of global infrastructure spending will take place in Asia. And it’ll happen in the next decade alone. China is set to lead the way on this front. And the yuan is going to profit from this movement.
The investment vehicle is the Asian Infrastructure Investment Bank (AIIB). If you’ve never heard of it, it’s basically China’s answer to the IMF or World Bank.
The AIIB is a bank which, as its name suggests, makes loan for infrastructure developments. This is important because it’ll give China a lot of influence in the direction of regional investment.
As the lender of first resort, the AIIB already has 57 member nations. The desire for nations the world over to join up is a sign of how much trust they’re placing in China.
From China’s perspective, the AIIB benefits them in two ways.
The first is that China retains control of the AIIB. That’s important because the Chinese have no influence over the IMF or World Bank. These two lenders have led the way as a source of loans for decades. And, much to China’s chagrin, they’re Western-led institutions. The AIIB, however, marks a major turning point towards the east. And it gives China the kind of influence necessary to taking a leading role in global governance.
The second benefit is that it will allow China to recreate the Silk Road. The ‘New Silk Road’, as it’s called, will weave Eurasia together, from China to Western Europe.
Improving transport infrastructure is important because it improves both China’s economic growth prospects and global influence.
As you might expect, the yuan is important to the future development of the AIIB. China is already pushing for the yuan to play a bigger role in loans denominated by the AIIB.
The most significant development since the euro’s introduction?
China’s current economic slowdown will be a drawn out affair. As the country transitions to a consumer-driven economy, it’ll have to undergo a readjustment to a ‘new normal’. That may mean that 7% growth rates become a thing of the past. But even 5% annual growth betters the performance of most other economies.
The real focus then will be on how far the renminbi can go. As the US dollar’s reserve currency status erodes, the yuan will pick up the slack. It’s not going to be the pound, the yen, or even the euro. The yuan is one currency that could overtake the USD as the global reserve.
The LME development is a minor step then in the grand scheme of things. But it speaks volumes about where things are heading.
Some liken the yuan’s rise on global markets as the most significant development in currencies since the euro’s introduction. I think it goes beyond that.
It’s the single biggest development since the US dollar attained reserve currency status.
Contributor, The Daily Reckoning
PS: AIIB investments in Asia are a big opportunity for Aussie businesses. With Asia making up more than half of global infrastructure spending over the next decade, the possibilities are limitless.
It helps that the leading nation behind the AIIB, China, is also our largest trading partner. Alongside the recently announced free trade agreement, we’re becoming ever more integrated with China.
The Daily Reckoning’s editor, Phillip J. Anderson, sees the benefits of China’s rise to Australia.
Phil disagrees with economists who say that slowing growth rates in China point to economic disaster. In fact, he thinks China’s boom is only beginning. And he says that it’s set to last another decade.
In a free report, Phil will show how you can profit from the mainstream’s ignorance. He’ll equip you with the right tools to invest confidently in China. To find out how to download his report, ‘The Cassandra Syndrome: After This Report, You Won’t Worry About China Again for Another Decade’, click here.