China's Plan for Winning the Currency Wars

By Mark Gilbert

The currency wars are still rumbling on. Today, Thailand became at least the 21st country to cut interest rates so far this year, as everyone tries to make their currency cheaper than everyone else's. The Federal Reserve still seems on track to raise rates in June, turbocharging the dollar. But there's more than one way to win a battle. You can inflict increasing damage on your opponent, which is what most of the world is doing to the U.S. Or you can gain territory -- which is what China is doing as its currency steals more and more of the global market.

The U.S. dollar's continuing ascent against almost every other currency in the world is capturing all of the attention in the foreign exchange markets. It's on such a tear that even the stock market finally started paying attention yesterday, with the S&P 500 index having its worst day in two months. For U.S. companies, the greenback's 12-year high against the euro and 20 percent gain against the currencies of its biggest trading partners in the past year threatens to trash exports and crimp overseas earnings. "A stronger dollar is undoubtedly a headwind for U.S. exports right now, and it’s a headwind for overall GDP growth," Jason Furman, chairman of the White House Council of Economic Advisers, said yesterday.

While rumors of the dollar's demise as the world's reserve currency of choice have been greatly exaggerated, the U.S. has lost some ground. It still has a dominant 62 percent share of global currency reserves, according to the International Monetary Fund, though that's slipped from more than 72 percent in 2001:

In the past year, the dollar's share of total global financial transactions grew to more than 43 percent from a bit less than 39 percent, according to figures compiled by the Society for Worldwide Interbank Financial Telecommunication, a global network that carries 20 million financial messages per day between 10,800 institutions in more than 200 countries. At the same time, China's currency became the world's fifth favorite medium of exchange, up from seventh at the start of 2014:

The euro is the real loser on the global stage. As the chart above shows, its share of total transactions declined to 28.75 percent from 33.52 percent in the past year. It's also less popular with the world's central banks. In 2007, Deutsche Bank was predicting that the euro would capture 30 to 40 percent of global foreign-exchange reserves by 2010, chipping away at the dollar's dominance. Instead, the euro's share peaked at 28 percent in September 2009, and has since slipped below 23 percent:

An oddity of the currency war that's quietly being fought in the background is that while everyone favors a weaker currency to boost exports and growth, there's still prestige in being the most-used unit of exchange. The efforts of various financial centers to win China's favor and become the leading offshore home for remninbi transactions is well chronicled, and now China itself is promoting its currency as a world beater. Simon Black, who runs the Sovereign Man service advising subscribers on second passports and overseas assets, alerted me to this billboard he spotted while travelling in Asia last week:

That billboard, though, isn't in China. It's beside the motorway that connects Bangkok with its airport. "China is literally advertising its currency overseas, and it's making sure that everyone landing at one of the world’s busiest airports sees it," says Black. "They know that the future belongs to them and they’re flaunting it."

The yuan still only accounts for 2.06 percent of global transactions, according to Swift. But that's up from 1.39 percent a year ago as it leapfrogged both the Canadian and Australian dollars. And as recently as January 2012, the yuan was the 20th most-used currency, not the fifth. If the U.S. is the loser in the currency wars, China is likely to be the long term winner.

To contact the author on this story:

Mark Gilbert at magilbert@bloomberg.net