Sunday, January 7, 2018

Could China use a collaboration with either the Pound or Euro to escalate their currency internationalization?

While the dollar is unquestionably the sole reserve currency in world use today, an interesting caveat must be mentioned in regards to how the currency is tracked.  By this I mean that the Dollar Index is not simply a tool to monitor the current value of the U.S. currency alone, but it is a mixture of several currencies that create a relationship versus and against the dollar's value.

  • Euro (EUR), 57.6% weight.
  • Japanese yen (JPY) 13.6% weight.
  • Pound sterling (GBP), 11.9% weight.
  • Canadian dollar (CAD), 9.1% weight.
  • Swedish krona (SEK), 4.2% weight.
  • Swiss franc (CHF) 3.6% weight.
So with this in mind, it is extremely unlikely as well as untenable for the Chinese to compete directly with the dollar simply by offering up the Yuan as a single challenger.  And while the RMB has increased its percentage as an international trade currency over the past five to ten years, it needs some other form of asset or collaboration to put itself on the same stage as the other five major currencies.

And that is why there is now growing discussions of China potentially forming a partnership with either the Euro or the British Pound to aid in their internationalization.

A great deal of thought is being dedicated to finding ways to avoid US power over dollars. Classic solutions (gold), techno-solutions (bitcoin etc) and plain old fake documentation have been stretched beyond their limits. Now sanctions evaders, resentful foreign officials and geeks are working on tweaks to the Chinese yuan. 
The obvious alternatives to using the US dollar payments system turn out, on closer inspection, to not serve the purpose. The principal banks in the euro area, the UK or Switzerland are so intertwined with the dollar clearing system they will not participate in any challenge to its authority. The same goes for the home banks of the other “Anglo” dollars. The Japanese have never liked the idea of the yen as an international currency. 
This brings us back to the Chinese yuan. Its prickly sovereign issuer is militarily independent, has substantial forex and gold reserves, a large economy and technological capacity. China has the explicit goal of turning the yuan into a major international currency, at the very least displacing the dollar in Asia. It even has a set-up called cross-border interbank payments system, or Cips, and bilateral “clearing accounts” with a host of other central banks. 
Naturally those looking for alternatives have alighted on the idea of avoiding the US by owning yuan and clearing transactions through Cips. 
Not so fast, say the Chinese. According to a July report of their International Monetary Institute, “the current Cips, with its focus on cross-border payments under trade accounts, fails to meet the needs of using RMB [yuan] on a large scale under capital accounts in terms of saving funds, attracting participants, and others”. So keep your hot money, for now. The Chinese know there is a long way from having a rudimentary and expensive payments system, to a fully internationalised payments and settlements system. Payments systems (such as Swift) are fancy and exclusive messaging services that say “pay this money to that account”. Settlements are where the actual money is exchanged with “finality”. Many other currencies can have trades settled through the global CLS Group, which provides secure 24-hour settlement finality. “ 
At present,” the Chinese report continues, “the urgent task is to build a legal system for the cross-border settlement system, improve the emergency plans for handling excessive cross-border inflow or outflow” and so on, mostly harmonising tax rules. Nice ambition, but the Communist party has its own ideas of what is “urgent” and who is in charge of laws and finality. 
There is a way, though, to create a transitional framework for the yuan as a dollar alternative. The City of London may lose bits of euro securities and derivatives clearing, but it has all the technology and staffing in place, not to mention English law. CLS has a heavy London presence, so you could have “finality”. 
Not simple, but possible. And there have been bilateral China-UK discussions about a London based “euro-yuan” trade. Why not? The Eurodollar market had its origins in Soviet and Chinese deposits getting away from US government hands. – Financial Times
With Britain facing a crossroads as they seek to disconnect from the EU financial construct, their need to forge new partnerships may actually lead to an accommodation with China, especially since they are a major point on the planned Silk Road 2.0 project.  And with the UK already a member of the AIIB bank, the potential of integrating each other's currencies to create a new and powerful competitor to the dollar is a win-win for both Britain and China, and could set forth a new age as the Bretton Woods agreement lies on its deathbed.


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