Dan Steinbock
In the long-term, Chinese renminbi enjoys strong prospects. In the short-term, it must cope with domestic and international pressures - and the US dollar as the new “fear gauge."
Recently, the Chinese renminbi fell to its lowest level since late 2008. Currently, it trades around 6.88 to US dollar.
The plunge is typically explained with the anticipated Federal Reserve rate increase in December and President-elect Trump's threat to label China a currency manipulator and slap tariffs on Chinese exports.
In reality, there is much more to the story.
Long-term strengths, short-term challenges
In the long-term, China’s growth will translate to might in foreign-exchange markets. In October, the renminbi officially joined the International Monetary Fund’s (IMF) international reserve assets. In the coming decade, the renminbi will expand rapidly through the IMF reserve basket, the allocations of central banks, and those of public, private, sovereign and individual investors.
After summer, the renminbi’s fundamentals improved thanks to positive spillover effects from overcapacity reduction, fiscal stimulus and a boost to export competitiveness, due to weaker exchange rate. Nevertheless, overcapacity cuts have been slower than anticipated and state-owned-enterprises (SOEs) could contribute to high debt-to-GDP ratios.
In the fourth quarter, the Chinese currency will also feel the adverse impact of a mild correction of property prices. Moreover, the government’s effort to implement its debt-to-equity swap program to reduce the role of non-performing loans (NPLs) in the banks’ balance sheets is not popular among those local governments that keep the debt-ridden zombie-SOEs afloat.
Chinese renminbi’s short-term volatility is also compounded by the tumultuous international environment and the US dollar.
US dollar drives crises, Chinese yuan supports stability
Along with other emerging market currencies, renminbi must cope with the US dollar, which recently hit a 14-year high, driven by rising US bond yields, expectations of a Trump fiscal stimulus and the impending Fed rate hike. In the process, other Asian currencies - Japanese yen, Indian rupeeh, Korean won, Indonesian rupiah and Malaysian ringgit suffered a sell-off.
In the long-term, the spillovers from the US and Chinese financial markets are likely to have a different impact in financial markets in Asia-Pacific. Central bank studies suggest that in normal times China’s influence in the equity market has risen to a level close to that of the US, although the relative impact of the US has been stronger in crisis periods.
The influence of China is based on a regional pull, while that of the US reflects a global push. The current crisis mode favors US dollar, but over time stability will support Chinese renminbi.
Unfortunately, the renminbi, along with other emerging market currencies, must also cope with US dollar’s growing risk in the world economy.
The US dollar risk
Before the 2008-9 financial crisis, there was a close correlation between leverage and the volatility index (VIX). When the VIX was low, the appetite for borrowing went up, and vice versa. That correlation no longer prevails, due to years of ultra-low rates and rounds of quantitative easing by advanced economies’ central banks.
Recently, the Bank for International Settlements (BIS) reported that the US dollar has replaced the volatility index as the new fear index. As the VIX’s predictive power has diminished, US dollar has become the indicator of risk appetite and leverage. This dynamic has distressing implications because it has pushed international borrowers and investors toward the dollar.
And yet, as dollar appreciation is exposing borrowers and lenders to valuation changes, US fundamentals are eroding, as President-elect Trump himself has acknowledged. US sovereign debt has soared to $19.9 trillion. And in the past year, foreign central banks sold almost $375 billion in Treasuries.
In these conditions, the Fed rate hikes could boost the US dollar as a kind of a global Fed funds rate, which would result in dollar tightening and deflationary constraints - which, in turn, could impair emerging economies that today fuel the global growth prospects.
It is not the Chinese renminbi but the US dollar that today poses the greatest risk to the global economy and serves as its fear gauge.
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