China recently announced it will be providing yuan-denominated loans to Latin American countries. This is a major macroeconomic development that marks another step towards the yuan positioning itself as a reserve currency capable of supplanting the US dollar as the currency of choice for international settlements. In other words, this is another step towards the US dollar losing its reserve currency status, which in turn paves the way for significant devaluation in the US dollar.
This news event in and of itself is not deeply meaningful; rather, it is when we see this event in the context of what China has been doing for several years now do we get a better idea of what is going on and how important it is to the macroeconomic picture. Here is a brief timeline of events leading up to this announcement of yuan-denominated loans to Latin American nations:
1. The IMF taking a greater role in establishing Special Drawing Rights ((NYSE:SDR)) as a currency to be utilized between nation-states to help reconcile international trade balances is an issue that has been discussed for several years now; the IMF even put out an extensive white paper (.pdf) last year outlining how this would work. The white paper mentions that SDRs would be a composite currency that could include the renminbi - but that the renminbi would need to be more of a free-floating currency first, so that it is conducive to international trade.
2. Accordingly, China has been positioning the renminbi to be a free-floating currency used in international trade. People's Daily reported that at least 40% of the China-South Africa trade, worth 100 billion US dollars, will be settled in RMB by 2015. Chile has already added the renminbi to its central bank reserves; so has Thailand, among others. Moreover, China has expressed support for renminbi trading in the US.
3. It should also be noted that China's central bank continues to aggressively accumulate gold. Is this a setup for making the renminbi a gold-backed currency? Many have speculated that this is the game plan. Certainly a currency that is gold-backed will have appeal as a reserve currency capable of storing wealth; indeed, the reason why the US was able to position itself as a reserve currency is largely because it was once pegged to gold.
So clearly, the news of yuan-denominated loans to foreign economies is part of a larger trend towards internationalizing the renminbi so that it can play a greater role as a reserve currency. What are the implications of this? What investment opportunities will it create? Here's a short list:
1. Given that central banks have been net buyers of gold (NYSEARCA:PHYS) since 2009, it is clear that gold is returning to the monetary system in some way. China is leading this push and seems prepared to push it even higher. Until there is a new international monetary agreement in place, I'll be holding gold -- and likely a significant amount relative to the rest of my portfolio.
2. Of course if the dollar loses exposure as a reserve currency to the yuan, the dollar will likely lose value. I play this routinely as a forex trader, though those who favor ETFs may find some opportunities in (NYSEARCA:UDN), a dollar bearish ETF. A more aggressive strategy could involving shorting long-dated US Treasury bonds via (NYSEARCA:TBT).
3. China bulls can use (NYSEARCA:FXI) as a simple way to speculate upon a wealth transfer from the US to China.
Ultimately, the advance of the renminbi makes hyperinflation of the US dollar more likely. A common argument is that hyperinflation cannot occur in the reserve currency; while I remain dubious of this argument (because capital can still go to gold) it will be a moot point if the dollar loses significant ground to the renminbi as a reserve currency.
The closer we get to hyperinflation, the more likely we are to get currency controls, shortages of critical goods, political reformations, and other developments that could result in a systemic breakdown of sorts in the US. If the US wishes to get off this dangerous trajectory, she will need to balance her budget and negotiate some type of debt cancellation agreement with the creditors that have lent the US 15.4 trillion - an amount that can never honestly be repaid.
Disclosure: I am long physical gold and short the US dollar relative to the Canadian dollar in the spot forex market.