PUBLISHED MON, JAN 14 201911:33 AM ESTUPDATED MON, JAN 14 20193:33 PM ESTRichard X. Bove
KEY POINTS
- China and its allies have placed a great deal of emphasis on using the yuan as a dollar replacement in many parts of the world.
- In areas where this has happened, it presents a threat to U.S. trade and economic health, writes Dick Bove, analyst at Rafferty Capital.
No one is likely to dispute the fact that China and its allies are working diligently to establish a multilateral world. In it China would control its own sphere from the eastern Pacific rim to the countries located along the historic “Silk Road.” That trade route stretched from East Asia to West Africa.
In this regard, a great deal is being written about the Chinese military build-up in the Pacific; the theft of technology secrets; unfair trade policies; and discriminatory investment practices. Very little focus has been placed upon the creep of the yuan and the expansion of the Chinese banking system. Yet, this might be the greatest threat of all.
China and its allies have placed a great deal of emphasis on using the yuan as a dollar replacement in many parts of the world. In those areas where this shift has occurred countries fall out of the United States orbit. This impacts U.S. economic health and, at some point, will affect the ability of this country to grow trade internationally and to fund its debt with international resources.
Yuan Creep
Prior to China joining the World Trade Organization in December 2001, only a few hundred banks in the world would clear transactions completed in yuan. A decade later, it was reported that well over 10,000 banks, worldwide would transact in the yuan. So many global entities were using the yuan that in October 2016, the International Monetary Fund (IMF) decided to include the yuan as one of four currencies backing its Special Drawing Rights (SDRs). In sum, the yuan had become one of the world’s reserve currencies.
The yuan had reached this lofty level due to a three pronged approach. First, countries that had historic issues with United States dollar dominance supported greater use of the yuan. They include Russia, Iran, North Korea and to some extent South Africa and Brazil.
Second, China isolated countries that were having difficulty accessing large amounts of dollar based loans due to poor repayment histories. In South America this included small nations like Ecuador and larger countries like Venezuela and possibly Argentina. In Africa, the list is very long. At the top is Angola, Ethiopia, and the Republic of the Congo.
The third group of nations are countries, primarily in east Asia, who trade heavily with China. In many cases, the Chinese demand that these nations use the yuan in all trading transactions. In fact, China has gone even further. It has established the Asian Infrastructure Investment Bank, a replica of the western world’s IMF. This banks is funded by China and lends to other Asian nations.
Stated crudely, the yuan is becoming the dominant currency in many countries with small and troubled economies but the world’s largest and fastest growing populations.
Why is this Important?
The American Century was built on many factors related to the stability of this nation’s economy; its strong military; and its financial dominance. Following World War II, one might argue that the dollar was the only currency in the world that mattered. Backing this currency was a large, relatively stable, banking system. If a nation wanted to trade internationally it had to have dollars and the only place to acquire them was from American banks.
Some would argue that this financial dominance led to the creation of the multilateral rules and organizations that fostered and incentivized the global growth that developed in the past 7 decades whereby virtually every nation benefited. If yuan creep continues these rules and organizations will be re-written.
Most importantly, large areas of the world will function under a new financial system orchestrated by China. From the perspective of the United States this would reduce this nation’s trade and its ability to fund its debt. Yuan Creep has the potential to cause major disruptions in this country over time.
How is the U.S. Reacting to this Threat?
Actually, the U.S. is unwittingly aiding Yuan Creep. This country is penalizing domestic banks that increase in size. It is putting operating restrictions on American banks that operate in global markets. It is using its banks to attack other nations with a variety of financial sanctions. It is penalizing foreign banks that compete with China in nations shifting their financial allegiances.
The United States is creating a financial vacuum into which the Yuan is creeping. The biggest banks in the world are now headquartered in China. The biggest U.S. bank is smaller than the fourth biggest Chinese bank. This is simply bad for this country.