Chinese Yuan Enters Reserve Currency Status with the IMF
If World War 3 is cyber-economic (and it is), the yesterday we just saw one of our most important weapons given away. Yesterday was a huge day for China. Christine Largade, managing Director of the International Monetary Fund announced that the Yuan has just taken its place alongside the dollar, Euro, British pound, and Japanese yen as an official reserve currency. The move has been expected for a while but was delayed in August.
Initially, the move toward China comes at the expense of the pound, yen, and euro while the dollar retains its dominant ranking in the IMF's special basket (known as Special Drawing Rights). Before today's announcement, the makeup of the basket was 42% from the U.S. dollar, 37% for the euro, 11% for the British pound, and 9% for the Japanese yen. Going forward, the dollar will still hold 42%, followed by 31% for the Euro, 11% for the yuan (also known as renminbi), and 8% each for the pound and yen.
While this is being reported as benign or even trivial (according to at least one University of Chicago professor), there are many serious implications that must be addressed. First, this seems pretty similar to the Iran deal. The West gave a lot of concessions and really got very little in return. The Chinese were desperate to get the status and recognition of a reserve currency. We should have demanded an end to their cyber espionage, theft, and hacking. When Presidents Xi and Obama met in Washington a few weeks ago, we were promised that the days of cyber crime were ending. Instead, they have ramped up and the stakes have gotten higher. We've also seen Chinese territorial aggression in the international waters of the South China Sea. Most recently, we've seen China moving toward satellite warfare which is potentially cataclysmic. We will cover that in a future post. But the fact is that the IMF, representing the West, has rewarded China with nothing in return at least for us. It is as if we see bestowing reserve currency status as somehow completely separate from China's cyber-economic warfare activities. The frightening fact is that we just handed the Chinese a powerful weapon and simultaneously reduced the value of our economic weapons, with regard to China but also rogue states like North Korea.
That's not an idle opinion but rather the analysis of The New York Times yesterday:
As the renminbi becomes more deeply woven into the global economy, it undermines the ability of the West to impose financial sanctions on countries accused of human rights abuses and other violations, as in the case of Sudan and North Korea. Such countries can increasingly do transactions in renminbi.
China contends that it is crucial to respect nations' sovereignty and that leaders should be allowed to set policy without fearing international criticism or intervention. China remains a close business and financial partner of Sudan and North Korea, even inviting the president of Sudan to a recent military parade in Beijing.
The United States is far and away the largest funding source for the IMF. Perhaps we should have exerted some influence to protect one of our most valuable economic weapons? Sadly, it appears this wasn't even an issue for discussion. In fact, we are making moves to support the use of the Yuan as much as possible.
Be aware that we long predicted that this day was coming. The so-called experts didn't even consider this possible a few years ago. Now that it's happening, we are told that it's a good thing… It won't hurt the dollar… It will bring China more into the community of nations. The problem is, however, that the push has been underway for some time and not by friendly forces. The idea was first proposed by a KGB buddy of Putin's. Replace the American dollar with a Chinese/Russian alternative and thus take control of the global monetary system. The plan was almost executed in 2008 although the Chinese authorities withdrew from the scheme and alerted us.
Initially, the plans to replace the American dollar were embraced primarily by elements in the People's Liberation Army. They understood that currency manipulation could be a powerful weapon as evidenced by their publication in 1999 of the book, Unrestricted Warfare. But in 2013, even the Communist Party was on board with a plan to "de-Americanize the world" by dethroning the dollar. The plan was laid out in 2011 in Quishi, an official Journal of the Party. Since that time, China's economy has slowed dramatically but this has not stopped a detailed plan to undermine our currency. The intention was to disguise the effort as normal economic moves. The problem has been, however, that China has regularly gone against what seemed to be their own short-term self interest in pursuit of longer-term goals. That's a hard concept to grasp with a Western mindset.
Recent moves made it clear that China is first seeking to establish the renminbi as a reserve currency and then ultimately to undermine the dollar completely. Of course, China is not a monolith. The business community and elements of the Party do not want an economic war with the U.S. But elements of the military and parts of the Communist Party absolutely have plans to dethrone the dollar in a financial war.
The Chinese have claimed to be moving more toward a free market economy. The fact is, however, that they have intervened a great deal in their economy even as it has weakened. They have dramatically sold down their holdings of U.S. Treasury bonds. They have added to gold reserves. They have propped up bad loans and even taken a huge stake in their own stock market. They've acquired American radio stations in covert fashion, seemingly with a plan to produce pro-China propaganda.
In global terms, they have put in place nearly everything necessary to replace the Western financial system, creating an alternative to the SWIFT transaction system and the World Bank. They have built trading relations with major nations to transact business without dollars. They have built processes to conduct oil trading in yuan, circumventing the petrodollar.
The Chinese are expected to get a huge long-term windfall financially from this decision that could be measured in the trillions of dollars. Now, they are buying up U.S. assets and it is just beginning according to Steven Schwarzman of The Blackstone Group:
"The Chinese are deliberate; there will clearly be large capital flows coming to the West," said Stephen A. Schwarzman, chief executive of the Blackstone Group, the largest private landlord in the United States. "That will increase in frequency until the Chinese government decides it shouldn't happen anymore — they've opened the spigot."
The problem is that as the Western investment in China is tightly controlled and always at risk of government interference or even confiscation. On the other hand, our more free and open economy can be more easily manipulated by the buyers. We seemingly lose both directions, which is typically the case in a rigged game.
The good news is that the dollar has at least temporary support from the fact that our economy, while by no means robust, is currently among the strongest in the world. The Federal Reserve has shown intentions to raise interest rates this month, making the dollar even stronger on world markets. Unfortunately, this masks the fact that the substantive long-term supports have been removed. It's like removing a solid foundation and replacing it with sand. Everything seems fine until the storm hits.
Ironically, a stronger dollar may work to China's advantage in the short run. It hurts our exporters and helps other nations export to us. If a currency war breaks out, we will be the initial loser. In the long run, however, if we lose reserve currency status, nations will no longer need to hold as many dollars among their currency reserves. This means that the market for our Treasury debt will be diminished. While not yet a problem (as the Fed has been funding the Treasury the past few years), it could cause trouble in the next downturn. In the short run, the Treasury Department will vary the type of bonds they issue, favoring short-term borrowing that rolls over quickly to keep interest costs down. This will mean we are having to refinance fairly often, however, opening the door for serious problems ahead.
Remember, our Federal debt continues to rise but the appetite for it may not keep pace. With growing supply and diminished demand, prices fall. Falling bond prices equate to rising interest rates which in turn produces more debt. It's a deadly spiral, once started. We've seen the ill effects in Greece quite recently.
The fact is that a $20 trillion debt is unprecedented. Without having the reserve currency or the petrodollar, we will find it increasingly difficult to locate foreign buyers for that debt. When the global economy recovers, American debt will not be so highly prized and we will likely find ourselves at the mercy of the IMF rather than the leader of it. Even Secretary of State John Kerry has admitted that there is a serious push to remove the dollar as leader of global trade. Today's IMF move to include the Yuan makes that much more likely.
What Can We Do About It?
For starters, we can reform our corporate tax code which would strengthen our domestic growth markedly. At present, corporations are using all sorts of loopholes to move out of the United States and avoid taxation. We need to close the loopholes and simultaneously lower the tax rates. Sadly, we have shifted so much manufacturing overseas due to bad tax policy that our domestic factory activity has contracted for the first time since 2012.
Next, we need to repatriate corporate earnings held overseas that won't return to America for fear of high taxes. The money has been earned outside the United States but companies can't bring it back to America without a penalty. But, if we gave a tax holiday for money brought back home and put to productive use, we would dramatically strengthen our economy. It would put people to work and get money circulating in the economy without causing unnecessary inflation. It would end the need for the Fed to manipulate interest rates. And it would match the "windfall" that China expects to receive from the Yuan's entry into the SDR.
Those two actions would put a strong and vibrant economy behind the dollar and make it more structurally sound, with or without the reserve currency or the petrodollar. It would clearly strengthen our economic arsenal and make America great again.