The movement of tectonic plates happens so slowly that we humans barely notice the shifts. However, taken in aggregate and over time, the changes are massive and literally earth shaking.
Such is China's currency policy. Dramatic, you say? Indulge me. For there are indications -- if only incremental -- that China is moving to make its currency, the renminbi ("RMB"), an international standard of trading -- if not an eventual replacement to the once-all-mighty USD.
The Bank of China, their fourth largest lender, just announced that it is allowing foreign individuals and firms and to trade in RMB, making it the first Chinese bank to widely offer non-corporate RMB deposit services outside Hong Kong and mainland China. The limits on these personal accounts are $4,000 a day and $20,000 a year, and are still heavily controlled by Beijing. Nevertheless, analysts are touting the move as a significant policy shift.
The announcement is part of a series of measures that have eased controls on the RMB. Up until recently, the Chinese government has kept a tight handle on its currency. Keeping the RMB low has been a key ingredient to domestic growth, which is dependent on selling cheap exports to the rest of the world. But over the last year, there are indications that the policy might be softening.
In addition to allowing BOC to open private foreign accounts, many international banks -- including HSBC, Standard Chartered, JP Morgan Chase, Citigroup, Deutsche Bank, Spain's BBVA and South Africa's Standard Bank -- are now offering RMB trade settlement and RMB corporate account services. The international trade settled in RMB has gone from zero to 350 billion (RMB) in just under two years. In another turn, the city of Shanghai has created a new investment window, allowing qualified firms to buy RMB and invest in Chinese companies.
Most importantly, the Chinese central bank in July of 2010 bowed to international pressure and agreed to allow its currency to fluctuate -- as much as .5 a day. Shortly thereafter, China began a RMB settlement system for cross border trade in Hong Kong. As a result, the RMB has appreciated significantly against the dollar -- over 3% -- since July.
What can these events tell us? They signal that China is making its move -- however slowly -- to position the RMB as a global trading standard, forgoing some of its control over the exchange rate. The reason is two-fold.
First, U.S. assets (and therefore the dollar) have proven to be less stable than they once were. The recent financial crisis -- brought on by U.S. speculation -- has shown us that. Further, our continuing deficits, mounting debt burden, unfettered public spending -- and a political stalemate over what to do about it -- give the international community pause. China, along with everyone else is worried about the full faith and credit of America. Why wouldn't they be?
Less willing to expose themselves to the slings and arrows of the U.S. economy, China is giving investors another choice -- the RMB.
But there's another reason. In order to keep the exchange rate near-fixed, China has had to print money like nobody's business. Based on China's regulations, for every dollar increase in foreign exchange reserves, the central bank has to release the equivalent amount of RMB into the economy.
As a result, China's foreign exchange reserves surged nearly 30% after it joined the World Trade Organization in 2001. By the end of last year, China's foreign exchange reserves were almost 20 times their pre-WTO level. In the past ten years, China's M2 (a broad measure of money supply) has expanded at the average rate of 18.8% a year, far above what it needed to sustain its GDP growth. M2 was up again -- almost 20% -- in 2010. This compares with 3.3% annual M2 growth for the U.S. over the same period.
All this excess money in China risks inflation, especially in their very hot real estate and commodity markets. Easing the exchange rate means that the Chinese can stop printing cash and can get a handle on potential inflation.
But what does it mean for the U.S.? As is so often the case with currency fluctuations, there's good and bad. On the positive side, if the RMB is more expensive, Americans buy fewer Chinese exports and Chinese buy more American goods. That's good because our trade deficit with China could shrink, which means China could hold less of our debt and we could become a less indebted country. Maybe.
The other side of the coin is not so pretty. A weaker dollar means... well... a weaker dollar. It means that American citizens are less wealthy relative to Chinese citizens and that we have less purchasing power on a global level. Further, if you believe, as many do, that the American manufacturing base is gone, the potential rise in American exports would not offset that negative.
The larger concern, though, is that a stronger RMB means China won't have to hold as many U.S. reserves, which means they won't have to buy as much of our debt. And if China doesn't buy our debt... who will? That could set off a whole series of problems in the U.S. -- interest rate hikes, inflation, and even potential debt default.
The rise of the RMB isn't going to happen overnight. Indeed, China is being extremely cautious. The RMB is still heavily controlled and will be for years to come. That said, slow movements don't mean small movements. As in plate tectonics, slow can still be massive.
Follow Meredith Bagby on Twitter: www.twitter.com/bagbyreports
The Bankers could still be rich and continue to own the USA, in financing manufacturing production in the USA. If they did 20 years ago, I could be buying a new car for $1000 and in that process the dollar could be stronger than it is today. But what the Bankers chose was to invest in China, so that their companies in China can hopelly control China's economy and thus the whole world and its mineral resources. So, what went wrong was that the Chinese were very patriots and enacted laws that put to death or life in prison, anyone involved even in small corruption. And the interest money China gets from these usa companies were put to use to finance the USA gov's useless wars and create more chinese manufacturing companies that are feeding the whole world and in return, to get a chunk of resource minerals back.
In brief, the Bankers cared less of USA Middle Class, they prefered more the money economy than production economy, as it was easier to rule the world without a strong usa middle class.
Yes China owns a lot of our Foreign Debt but not most of it...
Sometimes I think this China Owns us thing is OverBlown.
The United States’ trade gap is the proverbial “leak-in the-dike” with its de-simulative effect on our recovery. In November 2003, Warren Buffett in his Fortune, Squanderville versus Thriftville article recommended that America adopt a balanced trade model. The fact that advice advocating balance and sustainability, from a sage the caliber of Warren Buffett, could be virtually ignored for over seven years is unfathomable. Media coverage that China has kept it currency undervalued is a gross understatement, it has actually been keeping the U.S. dollar over-valued; which adversely affects all our trade with all our trading partners, not just trade with China. Until action is taken on Buffett’s or a similar balanced trade model, by the powers that be, America will continue to squander time, treasure and talent in pursuit of an illusionary recovery.
as the chinese purchase our treasury notes they are creating rmb that essentially monetizes the USA debt. It is a nice game for fools, but it does not work for the long run. Where were Greenspan at the Fed and the successive Sec of Treasury over this past decade? We are painted into the corner by our own boys and the Chinese have to snicker at the lack of our capitalist prowess.
You clearly get your 'talking points' from listening to political pundits, and not by reading international economics.
But the political pundits Have to make it entertaining... and Scary..... otherwise the story would be just another trifle.