The renminbi black swan

Take $1,500bn in Chinese dollar reserves, add generous dollops of concern about currency debasement, mix in a shopping spree by the Chinese state. Then scream.

At least, you should be screaming if your life savings are in dollars.

Recent Chinese buying of hard assets is by no means simple investment or long-term preparation for a rapidly growing population and economy, according to boutique brokerage Aviate Global.

No, the Chinese are buying, they say, because they are quietly tip toeing away from the dollar and hoping that no one else will notice:

The investment community is waking up to the reality that China is buying hard assets (gold, precious metals, oil, copper/ally etc) for more than simply industrial purposes. They have $1.5tn in $ reserves. They understand the $’s day as a reserve currency is over and hold the biggest key to future debasement: full Yuan convertibility.

“Full yuan convertibility” refers to what could be the end stage of a process of internationalising the renminbi by eventually allowing it to float freely against other currencies.

There has long been discussion of China being caught in a “dollar trap”: unable to sell its huge dollar holdings without destroying the value. To escape, so the theory goes, Beijing has clocked onto the idea it has to make the renminbi a viable reserve currency.

Indeed, recent actions have provided fodder for this view. China’s Vice-Premier Wang Qishan is creating a new task force to transform the yuan into a currency used in international trade, and have opened renminbi currency swap lines this year with Argentina, Belarus, Hong Kong, Indonesia, Malaysia, South Korea, and – soon – Russia.

According to Qu Honghin, an economist at HSBC, the first phase of this internationalisation process,

will focus on expanding the renminbi’s role in settling cross-border trade. If successful, this could lead to nearly USD2trn in annual trade flows (40-50% of China’s total) to be settled in renminbi each year by 2012, making it one of the top three currencies in global trade.

But as the renminbi becomes increasingly used for international trade, it will appreciate against the US dollar from current artificially low levels. The Chinese know this, so are switching out of dollars into strategic assets. Aviate continue:

[Full Yuan convertibility] could cause the $ to fall faster than its current decline rate. Before they would do this, however, they will continue to hedge that position. The ONLY way they can is in buying hard-assets (and producers thereof).

This looming renminbi “black swan”, as they label it, means the only sensible long term option is to be short the greenback and long commodities and commodity-linked companies.

It comes as no surprise to us that there are reports from China they are pressuring state-controlled organisations, like the China Investment Corporation (CIC) to rapidly build investment in non-Chinese enterprises, notably hedge-funds and commodities. This fits our view. Government procurement policies are more about strategy than purely industrial purposes.

The conclusion is that China recognises that the $ is going to tank and it wants to convert as much of its reserves into strategic assets as possible before the collapse really takes hold.

Related Links:
Beijing’s dollar trap
– FT
Another day, another dollar debate
– FT Alphaville

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