Saturday, 6 June 2015

The Next Global Reserve Currency...from Daily Reckoning

Daily Reckoning
June 6, 2015
  • Chuck Butler places his faith in China’s “treasure chest”...
  • A way to play six emerging market currencies, with no risk...
  • Then, Chuck explains why he believes the yuan will be the next global reserve currency and what it means for your investments...

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Baltimore, Maryland
June 6, 2015
Peter CoyneDear Reader,

“Economists could give you 100 reasons why China will land softly” explained our friend, Chuck Butler, last month, “and another one could give you 100 reasons why not. I simply look at what I call their ‘treasure chest of reserves’ -- nearly $4 trillion. It’s mostly dollar-denominated assets. I also look at the huge, huge pot of gold they have.”

Chuck was kind enough to make time to get on the phone and explain his forecast for the Chinese economy, its currency and the impact both will have on the de-dollarization trend underway globally. 

His conclusion? Power was shifting from East to the West... and sooner than you might think. Recall the “plateau” version of the future that we examined on Wednesday. It suggested “the whole world will converge toward a plateau of development similar to the life of the richest countries today.” 

“It’s a communist country, I understand that” added Chuck. “I don’t ever want to have people think that I'm glorifying a communist country. But what they’ve been able to do over the years is move to a position of power and strength in that they have a huge treasure chest of reserves.

“When they have a slowdown in their economy they can just point to that and apply stimulus to get their economy going again. It wouldn’t cause major problems in the country because they wouldn’t increase the debt; they wouldn’t rob Peter to pay Paul.

“They would basically take from their reserves and fix the problem. That’s one of the good things that they can do because of their political system. Though, even the U.S. could do that, if, in fact, we weren’t running an $18 trillion deficit. 

“That’s why I think that they’ll be able to have a slow landing and transition their economy,” said Chuck in conclusion. “They’ll also be even better prepared to float their currency by the end of this year, back it with some sort of percentage of gold and make it the most attractive currency in the world.”

Chuck explains why he believes the yuan will be the next world reserve currency and what that means if you hold dollars, below...


Peter Coyne
for The Daily Reckoning

P.S. It’s worth your time to check out the Future Economies MarketSafe CD that EverBank, which Chuck’s a part of, has issues. The only catch is that you’ll need to act quickly to take advantage of it. 

Why the rush? According to the mainstream media there’s nothing to worry about -- the U.S. dollar is very strong right now.

But, as we’ve explained in these pages before, that’s only because, at the moment, other central banks are printing money at even faster speeds than the Federal Reserve. That can’t last forever. With signs of a slowdown, it could be only a matter of time before the Fed reverses their course and the dollar goes into a steep decline.

The only real question is whether we’re in for a slow, steady fall or a sudden collapse.

But you can be prepared either way thanks to Chuck and his colleagues at EverBank. With their MarketSafe® Future Economies CD you get exposure to six emerging market currencies -- the Brazilian real, the Chinese renminbi, the Indian rupee, the Indonesian rupiah, the Mexican peso and the Turkish lira.

All six are could benefit from a falling U.S. dollar. And as Chuck explained, if the CD matures with just a .01% profit -- EverBank will pay you 10% on your initial investment at maturity. And if the final value exceeds 10%, you’ll get the higher amount.

So that’s a potential minimum gain of 10%... and after that the sky’s the limit.

Please take a closer look at the fact sheet they’ve created for you. You’ll learn everything you need to know, including some examples of how you could see profits. You need to hurry, though, the funding deadline is June 11.

Click here for more info. For sake of full disclosure, we have a marketing relationship with EverBank, but we’d work with them regardless.

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The Daily Reckoning Presents: What comes after the dollar?
The Next Global Reserve Currency
By Chuck Butler
Chuck ButlerI will admit some trepidation in beginning this morning’s commentary with such an audacious title, but long-time readers of the Daily Pfennig®newsletter should be neither surprised at my confidence in making such a statement, nor shocked that I would pull no punches in sharing my views on a topic as particular to me as the outlook for the Chinese currency, the renminbi.

In late 2008 and early 2009, the Chinese government began signing bilateral currency swap agreements with a number of trading partners, including South Korea, Hong Kong, Belarus and Indonesia. These currency swap agreements essentially provided a medium of exchange directly between the two respective countries, removing the U.S. dollar from the terms of trade. 

Shortly thereafter, I authored a letter for a Sovereign Society publication espousing alarm over China’s decision to sign a similar bilateral currency swap agreement with Argentina, China’s first such venture outside its immediate trading area. The significance of this particular currency swap agreement, as I wrote at the time, was that the Chinese government had officially launched its initial salvo against the reign of the U.S. dollar as the world’s reserve currency.

Since that time, the People’s Bank of China (PBOC) has entered into 30 bilateral swap agreements with trading relationships across the globe, including some pretty heavy economic hitters joining the ranks under bilateral currency swap agreements with China (Figure #1). 

I also made a presentation at a February 2010 conference stating that it was my opinion that the days of the U.S. dollar remaining as the world’s primary reserve currency would end by the close of this decade. With five years remaining in the decade, and based on the progress the Chinese government has made thus far over the last five years, this forewarning may yet prove to be conservative.
Figure 1
Source: EverBank Research Team, based on analysis of publicly available data from the Harvard Dataverse Network, People’s Bank of China.
Chinese economic liberalization initiatives are certainly not limited to the currency markets. In November 2014, the Chinese government launched a pilot program linking equity markets in Shanghai and Hong Kong, allowing investors the ability to trade directly across the Chinese border in renminbi-denominated stocks, and representing “one of the most significant liberalizations of China’s capital markets in years.”

Similarly, China has expanded access to its domestic bond market with the May 2015 approval of an additional 30 large foreign institutions permitted to invest directly in the country’s $5.9 trillion domestic bond market.

Moreover, the PBOC has formally requested renminbi inclusion in the International Monetary Fund’s (IMF) Special Drawing Rights (SDR) reserve basket of currencies, an international reserve asset held by the IMF to supplement member countries’ official reserves. 

At present, the four reserve currencies included in the SDR basket are the Euro, Japanese yen, British pound sterling and U.S. dollar. Suffice it to say, the Chinese government has the renminbi on a defined and concentrated path to join the ranks as a world reserve currency.

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So why the “sudden” push for the Chinese government to open its capital markets, enter into bilateral currency swap agreements, and challenge the U.S. dollar on its leadership position as the global reserve currency? 

The situation reminds me of the old financing adage: You should buy assets that appreciate and lease assets that depreciate. The PBOC appears ready to begin leasing U.S. dollars! Quite simply, the PBOC may be weary of holding U.S. dollar reserves in order to conduct global trade, given the manner in which U.S. bureaucrats and monetary officials have been managing internal finances.

The Chinese government certainly seems to feel confident that the time has come for the renminbi to take a leadership role on the reserve currency stage, and with good reason. The Chinese economy is now the largest economy in the world, passing the United States at the end of 2014 based on IMF estimates.

China is also the world’s largest exporting economy, trading $2.3 trillion in merchandise exports relative to U.S. exports of $1.6 trillion. Gross national savings in China now represent 49.5% of Chinese gross domestic product (GDP), compared with U.S. savings at just 17.3% of GDP.

China surpassed the United States in terms of manufacturing in 2010, and is now the world’s largest manufacturing nation with nearly $3 trillion in annual production output, compared with roughly $2.4 trillion in U.S. output. In fact, one-in-four automobiles sold worldwide are now manufactured in China.

The Chinese economy is also the world leader in gross value of agricultural output for rice, wheat, potatoes, corn, peanuts, tea, millet, barley, apples, cotton, oilseed, pork and fish. Based on Organisation for Economic Co-operation and Development estimates, the Chinese government provided farmers $165 billion in agricultural subsidies (2012 estimate), relative to Japan’s $65 billion and the United States’ $30 billion in agricultural subsidies.

By acquiring nearly $4 trillion in reserves of foreign exchange and gold, guess where China ranks in terms of global reserves? 

You got it: No.1.

China is also the world’s largest producer of gold, more than twice the production in the U.S., and is also now the world’s largest importer of gold placing the country ahead of India.

Of course, the Chinese economy is not performing without challenges. Some observers contend that the renminbi may be at risk due to the Chinese economy slowing lately. However, prior to the current era of monetary intervention, economies would naturally cycle through periods of expansion and contraction. Moreover, the financial law of large numbers contends that large entities growing rapidly cannot maintain high growth rates in perpetuity.

Critics also point to recent accumulations in local Chinese government debt, but as I pointed out in a recent Daily Pfennig®article, it makes perfect sense for a government to accumulate debt in a low interest rate environment. 

The difference, however, between China’s debt accumulation and the U.S. debt accumulation is first, China has been investing in infrastructure with presumably positive investment returns, and second, the Chinese government has $4 trillion in reserves to help offset this increase in debt, as needed.

In analyzing the progression toward a free floating and tradable renminbi, I would expect the sequence of events to unfold as follows: China continues to open its capital markets to foreign investment. Investors provide additional liquidity to the Chinese economy through bond purchasing. 

The IMF accepts the renminbi as one of its reserve currencies in the SDR – which, coincidentally, is rebalanced at the end of 2015 – under the condition that the PBOC eliminates the renminbi peg to its current basket of currencies.

Then the renminbi becomes a floating currency, and the Chinese government subsequently allocates a percentage of its massive gold reserves (and other hard assets) as backing to the outstanding currency float. Under this type of scenario, the renminbi may have a real opportunity to become one of the most attractive major currencies in the world relative to its fiat currency contemporaries.

Furthermore, if the renminbi is successful in becoming a reserve currency in the IMF’s SDR reserve basket, the IMF will be required to purchase an estimated $1 trillion in renminbi for the SDR holdings, also potentially driving up the value of the renminbi, assuming the currency is floating at that point. Clearly, it could be an interesting environment for the renminbi.

On an interrelated point, a fully floating renminbi could have far-reaching consequences for the U.S. dollar, particularly if or when the renminbi eventually assumes a position as a global reserve currency. Once global trading partners are no longer required to trade exclusively in dollars, countries will similarly be released from requirements of holding massive amounts of dollars in reserve, and eventually, the dollar could get sold. 

Could this be the Minsky moment that would place the U.S. in the same predicament that Britain found itself after losing its reserve currency status? Time will certainly tell. However, in this given scenario, U.S.-based asset values and interest rates could potentially be in for a tough run if this were to unfold.

Before I end, I want to emphasize that this view is my personal take on how things could unfold for the Chinese renminbi and the U.S. dollar. 

Obviously, in today’s dynamic world, any number of scenarios is possible, which means I could completely miss the mark. But, to me, there just doesn’t seem to be much left in the tank, and you can count on us to keep a close eye on future events. Time will tell if I’m right or wrong.


Chuck Butler
for The Daily Reckoning

P.S. The funding period on our the Future Economies MarketSafeCD ends on June 11.

It’s a five-year U.S. dollar CD that has a semiannual pricing based on an index. It doesn’t pay interest. What happens is that every six months we stop and take the prices of all the currencies in the CD -- which include the Brazilian real; the Chinese renminbi, the Indian rupee, the Indonesian rupiah, the Mexican peso and the Turkish lira -- and we record them.

At the end of the CD we add up all those six-month prices and if the average price over that period of time is greater than the initial price, that increase is yours. And if it’s below the original price, you get your all of your principal back. 

And it has an added kicker to it. It has what’s called a jump-note feature. All that means is that if the currencies only manage to gain, let’s say, 0.2% or even 0.1%, or anything above zero, then you automatically get a 10% return on your principal at maturity.

But if it’s above 10%, if the actual return is above 10%, then you get whatever it is. So let’s say those the average price over the five years is a return of 20%, then that’s your return. But if it’s 9%, you get 10% instead.

There are a few more details. The minimum funding amount is only $1,500. And of course EverBank is a Member FDIC. 

Keep in mind; you cannot withdraw this money during the five years, so it has to be money that you’re not going to have any use for. The only way you can withdraw it is if you die, and nobody wants to see that anyway.

The MarketSafe CDs are also IRA eligible, so you can put them in your IRA. There’s also a deadline to get in on our newest Future Economies MarketSafe CD. Again, the funding period ends on June 11.
Chuck ButlerChuck Butler is the Managing Director EverBank Global Markets. The father of the Daily Pfennig®newsletter, Chuck has a career in investment services and currencies spanning 35+ years.

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