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9/29/13

China: Renminbi: Soon To Be A Reserve Currency? - by John Mauldin

One of the prerequisites for a true reserve currency is that there must be a steady and ready supply of the currency to facilitate global trade. The United States has done its part in providing an ample supply of US dollars by running massive trade deficits with the rest of the world, primarily with oil-producing nations and with Asia (most notably China and Japan), for all manner of manufactured products.

The US consumer has been the buyer of last resort for several decades (I say, somewhat tongue in cheek).

Those dollars typically end up in the reserve balances of various producing nations and find their way back to the US, primarily invested in US government bonds. In an odd sense, the rest of the world has been providing vendor financing to the US, the richest nation in the world.

China has a massive comparative advantage that most people never think of. If I asked, "What's China's comparative advantage?" 99 out of 100 people would say "cheap labor," but that's not true. Labor is not that cheap in China anymore. China's comparative advantage is that China – alone amongst emerging-market nations – has a deep and credible financial center. It takes 50 years to build a financial center – to, you know, have auditors, lawyers, accountants, judges. And China is very lucky, because in 1997 the Brits – who are quite good at building financial centers – basically built one in Hong Kong and told China, "Here it is. Try not to mess it up."

For twelve years, China did nothing with Hong Kong. It was kind of a deal of "You don't bother us, we won't bother you. We've got other fish to fry." And that worked well until all of a sudden, in the past two to three years, China has been internationalizing its currency through Hong Kong, and it is taking off like wildfire.

We always talk about what you see and what you don't. Everybody talks about the China slowdown. Everybody talks about the impact this is going to have on commodities, on countries like Canada, on countries like Australia. Nobody talks about what you don't see. And what you don't see is that China is slowly but surely internationalizing its currency. It's slowly freeing capital controls. It's creating deep and liquid capital markets, and this is going to change the way that companies and individuals finance themselves among emerging markets. It's going to make for more stable emerging markets and hopefully for higher growth.

China is on its way to becoming a reserve currency not because of weakness in the US dollar but precisely because the US dollar is going to get stronger and become less readily available. Countries are going to need to be able to trade in something besides dollars. It simply makes sense that if 20% of an emerging-market country's trade is with China, it should do the trades in RMB rather than in relatively scarcer dollars. Of course, this means that China needs to have a relatively stable monetary policy so that its trading partners will have confidence in the long-term RMB, but China realizes that. And of course the RMB will have to meet all the other requirements for being a reserve currency.

Read more: Renminbi: Soon To Be A Reserve Currency? - Business Insider

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