How China Will Use the Yuan to End the US Dollar Standard

The most interesting news over the long weekend wasn’t to do with the Spanish bailout. The most interesting news is that China is moving to internationalise its Yuan currency. The steps are gradual, mind you, but in the long game of global power through monetary conquest, every step is progress toward the goal. The goal is ending the US dollar standard.

The tiny step China’s regulators took last week should promote more liquidity in yuan denominated trading. Specifically, China now allows Chinese banks to conduct non-principal exchange currency swaps. That might not sound like a big deal, but it’s a start.

First, a non-principal exchange currency swap is when two parties (Chinese banks) reach an agreement to exchange interest rate payments on their respective loans. The loans are denominated in separate currencies (US dollars and yuan). The exchange – not of the principal on the loans but just the interest – is a way for Chinese companies to hedge foreign currency exposure.

For example, a Chinese company that sells US dollar-denominated bonds may want to hedge its risk. It can do so by swapping interest rate payments with another counter party. Insurers might do the same thing.

Any Chinese business that issues bonds, loans or other kinds of debt would be the kind of entity interested in this kind of currency hedging. And if a foreign company decides to issue bonds in Chinese currency, it would also seek to hedge its interest rate risk.

Now that we’ve typed all that, we can see it may not actually sound that exciting. After all, hedging interest rate risk through the derivatives market is routine. It happens every day, in US dollars.

It does not happen all that much in yuan, though. And in point of fact, the first such exchange that took place last week was only for the sum of $10 million. It was between HSBC and the Industrial Bank Co. History will little note nor long remember such a small transaction.

The important point, though, is that China is slowly liberalising its capital account by internationalising its currency. We don’t believe China is trying to position the yuan to replace the US dollar as the world’s reserve currency. China is reluctant to open its capital account to foreigners and make the yuan freely convertible on international markets, because of the potential damage to its banking system (Chinese savers sending money abroad). This is precisely the issue we wrote about in the most recent issue of Australian Wealth Gameplan.

However, the US dollar system is broken. And China is not stupid. It knows that as the global debt crisis burns its way from the periphery of the global system to the core, its dollar holdings are at risk. It can’t hedge that risk now, but it can prepare the currency battle space for a new global monetary system.

Since it’s a short week, we won’t go into what that system might look like. But one certain aspect of it is more liquidity in yuan-denominated debt and interest rate instruments, including derivatives. China wants to make it easier for the world to conduct transactions and engage in commerce through its currency. Last week’s move was one small step toward that big goal.

When will the big transition to a new monetary system take place? HA! If we knew the answer to that life would be so much easier. It’s the most important question to answer for the next 50 years. The transition from this system to the next will destroy the savings of the Western world’s middle class. You have to understand it and prepare for it, or you’ll be collateral damage. Our view is that it’s coming to a head in the next 36 months.

But 36 months is a long time in financial crisis terms. Come to think of it, 36 HOURS is a long time in financial crisis terms.


Dan Denning
for Markets and Money

From the Archives…

The Avalanche and the Phase Transition of the Financial System
2012-06-08 – Greg Canavan

A Financial Crisis that Repels Private Capital
2012-06-07 – Eric Fry

Floating Towards Japan’s Economy on a Sea of Bad Debt
2012-06-06 – Bill Bonner

Pirate Politics to Save the European Union
2012-06-05 – Nick Hubble

China’s Economy?Where All is Not As It Seems
2012-06-04 – Greg Canavan

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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I was just yesterday thinking to myself, after having read Peter D Schiff’s ‘Why an Economy Grows and Why it Crashes’, “I wonder how the US will finally be forced to give up their reserve currency status, and more importantly, when?”.

Thank you for giving me your point of view on the matter of both unasked questions, my thought processes can go on unabated!

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