Warning shots fired across the bow by the chinese over US dollars reserve status

Just a few days ago the exchanges of Hong Kong and Singapore signed a Memorandum of Understanding with the intent of joining forces to create more products denominated in the Chinese renminbi. The move seems harmless and uneventful, just part of the day-to-day activities of these exchanges, but is it really? There could be far-reaching consequences of this move, particularly when considered within the international context…

The Hong Kong and Singapore exchanges are the two most important financial centres in Asia, equivalent to New York and London in the western world. With the US dollar the Globe’s reserve currency, and which serves as basis for international trade, one scratches one’s head as to why they would want to redenominate trade in the renminbi instead of in the traditional way – based on the US dollar.

When we look at the international picture what we see is that more and more institutions, organisations, countries and trading partners are seeking alternatives to the dollar, as the Bitcoin price explosion is a good recent example of.

The dollar, as with any other paper currency these days is backed purely by the good faith of its Govt, in this case good Ol’ Uncle Sam. Until 1973, the dollar was in fact backed by real gold and so had a real value underpinning. During the last 10 years however, economic growth has been sluggish in the US and monetary policy has been tailored towards managing a frankly insurmountable debt pile in the country. The dollar has been used as a debt monetisation tool and is being continuously debased.

The setting of alternative trade mechanisms is thus an appropriate and understandable way of counter-balancing the negative events that are currently, and will very likely continue to affect the dollar. China keeps a trading zone with neighbouring countries where they negotiate and trade in renminbi instead of using the dollar. Many other countries who previously accepted the dollar for bilateral transactions even though it was not their base currency are also now looking for alternatives.

According to data published by the Society of Worldwide Interbank Financial Intercommunication (the well-known SWIFT), the dollar is still the most important currency for international settlements, representing 80% of transactions, but it has been losing market share. The renminbi in contrast is growing in importance and it is now the second most used currency in the world with a share of around 8.6%. Its rise has been fast paced during the last 18 months as in only January 2012 the currency had a market share of just 1.9%.

In order to remain as a reserve currency, the Fed will likely need to halt their massive money printing policies which will eventually generate inflation, thus representing a potential loss for all those who hold it. But with “on balance sheet” (let alone off balance sheet like medicaid etc) sovereign debt well in excess 100% of GDP, policy makers have, in a tried and trusted manner (even though they have all ended in utter and abject failure), found that the best way to tackle the debt mountain is through money printing rather than through tight fiscal measures which have the malefic consequences we have seen throughout Europe…

The problem at this point is that there is no single currency with a sufficient status to substitute the dollar outright. We should not ignore the first warning signs over the bow to the US Monetary authorities however. A new world order is in the process of being made and our guess is that in 20-30 years time the US dollar will no longer enjoy the privilege of its Reserve status. The major economic superpowers in the East are continuing to prepare and make their moves…