Is The Renminbi A Threat To The U.S. Dollar?

Includes: AXJL, CYB, UDN, UDNT
by: Cameron Swinehart

Since 2008, The People's Bank of China (PBoC) has aggressively taken steps to "internationalize" its currency. The Chinese government has been seeking financial stability and promoting its currency (the renminbi or RMB) for trading and investment. Through the use of bilateral swap agreements (BSAs) and the creation of offshore currency centers, the PBoC has attempted to expand the availability of the renminbi. The aggressive use of these agreements by China was initially to make trading with a variety of its trading partners more efficient.

As of August 30th, the USD/CNY is right around 6.12. Back in September of 2012 the USD/CNY was trading around 6.35. As shown in the chart below, the USD has been in a steady decline relative to the renminbi.

(source: Yahoo Finance)

As noted by the Wall Street Journal on August 16th article:

"The yuan, officially known as the renminbi, is on course for its fourth consecutive weekly gain and has risen 2% this year. The Shanghai Composite Index, meanwhile, is up nearly 10% this month"

The article also notes to expect further strengthening of the RMB against the USD due to higher interest rates in China. The chart below shows the PBoC benchmark interest rate at 6%.

Some reports have indicated the possibility of the RMB being backed by gold. These reports have been trickling out for over the past year. As Doug Casey of Casey Research commented:

"All it will take for the world to realize that U.S. dollars are nothing more than hot potatoes is for one country (Doug postulated that maybe China would be first) to introduce a gold-backed currency. If China introduced a gold-backed yuan, for example, who on earth would want anything to do with U.S. dollars?"

A variety of experts refute the idea of gold back yuan and see the Bank of China instead wanting the RMB to be a part of the Special Drawing Rate or SDR. As Jim Rickards stated in a recent interview:

"China is not buying gold to create a new gold standard; rather it is aiming to make the Yuan more attractive, with the end result of being included in a basket of currencies, referred to as the Special Drawing Rate [SDR]. He added that there is a move to make the SDR the new global reserve currency."

Rickards, the author of Currency Wars: The Making Of The Next Global Crisis, pictures the transition coming very soon:

"Everybody knows that the U.S. dollar's days are numbered but there is no really currency to take its place except for the SDR,"he said. "What the world is trying to do is move to the SDR and China is fine with that."

I happen to agree with Rickards. It does appear that China simply wants to assimilate into the global currency system with the PBoC's recent actions. As Rickards noted, China lacks the monetary infrastructure to become the worlds reserve currency.

Below is the WisdomTree Chinese Yuan Fund (NYSEARCA:CYB) that tracks USD/CYN.

(Source:Yahoo Finance)

Here are few ways to play strengthening RMB and a weakening USD: Powershares DB US Dollar Index Bearish (NYSEARCA:UDN), Powershares DB 3x Short USD (NYSEARCA:UDNT), or WisdomTree's Long Yuan relative to the $US as shown above. I also like WisdomTree's Asia Pacific ex-Japan (NYSEARCA:AXJL). It provides broad exposure to growth in Asia and at current levels offers +3.5% dividend. You can also trade the actual currency themselves.

As insurance, gold (GLD, IAU) and other precious metals (PMs) like silver (SLV, PSLV), are preferable long-term investments with continued USD devaluation. China seems to be buying up as much gold as it can get its hands on. I expect strong demand for PMs continuing into 2014.

Obviously, China has its own share of problems. However, when looking at these latest agreements and actions by the PBoC, Asian investing opportunities seem more attractive going forward. China is now the second largest economy in the world accounting for roughly 13% of the global GDP and expected GDP growth of 7.5% this year (Trading Economics). In terms of the US dollar, I don't believe its status as the world reserve currency is in danger in the near term. In the long term, with currency devaluation, rising US debt and the prevalence of competing currencies; the demand for the US dollar as a reserve currency could be in trouble.

Disclosure: I am long PSLV, PHYS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.