Why The RMB Isn't Going Global

Includes: CNY, CYB, FXCH
by: Christopher Balding


Fall in the RMB is less than the fall in other major USD currency pairs.

Slowdown in trade not highly correlated in directionality or magnitude with the RMB.

RMB reversal due to price and capital controls imposed by Beijing.

An argument has been made that the RMB has failed to become a major international currency because it fell against the USD. Apologists both inside and outside China have come up with increasingly elaborate reasons why the RMB has failed to gain traction on international markets. Two primary arguments focus on the fall of the RMB and the slowdown in global or Chinese trade. The RMB has fallen by a grand total of 12.8% from 2014 to 2016 for an average annual decline of 4.1%. However, by the standards of major currency movements this is irrelevant. Let me give you two facts to put this in perspective. First, since the beginning of 2014, the RMB against the USD has enjoyed the smallest within year peak to trough movement compared to other major currency pairs. Here I am including the USD against the JPY, EUR, GBP, CAD, AUD, and CHF. In other words, this supposed extreme movement is actually quite small compared to other currency shifts.

Second, of the currency pairs considered, the RMB was actually the third smallest declining currency against the USD from January 1, 2014, to December 31, 2016. The RMB is only slightly worse than the JPY and the CHF by 3.1% and 1.4%, respectively. This, however, is far better than the declines in value of the EUR, GBP, CAD, and AUD falling 23.1%, 24.8%, 26.0%, and 19.1%, respectively. In short, the idea that investors were scared off a declining RMB or some type of volatility is factually wrong.

Nor does the argument that the RMB failed to become a global currency due to flat or declining international trade levels stand up to scrutiny. While the factual point is accurate that China has experienced flat or declining trade growth, this has no bearing on whether the RMB could have become a major global currency. Let me give you three points to consider. First, China is the largest trading nation on the planet, but somehow China is helpless to trade in their own currency. Where else could anyone make a remotely credible argument that the player with the largest market share has no influence over a market? Think about writing with a straight face that Microsoft (MSFT) has no impact on the operating systems market or that Apple (AAPL) cannot influence the smartphone market. To argue that the largest trading nation has no influence on the currency it trades in is simply not credible.

Second, walk through a quick thought experiment that will demonstrate the trade slowdown is irrelevant to the analysis. A) Assume that Chinese trade expands 20% every year during this period but it still decides to impose strict capital controls withdrawing offshore RMB to control the USD/RMB exchange rate or B) Assume that Chinese trade is what we have seen the past few years and China decides instead to push traders to invoice in RMB, let RMB flow into offshore markets, and allow global markets to set the RMB/USD price. Will scenario A or scenario B result in a more globalized RMB? Clearly scenario B.

There are two key points at play here. First, fundamentally, trade growth is irrelevant to whether the RMB becomes a global currency. As noted, China is already the largest trading nation in the world, which effectively limits to some error rate around the global average. It simply cannot grow much in excess of the global average. For the future, China will never be able to globalize the RMB if it needs as a pre-condition double-digit growth rates in trade. Second, it remains entirely a policy decision of the Chinese government, not an exogenous variable foisted upon the RMB or Beijing, whether the RMB becomes a global currency.

Finally, the argument that RMB globalization will grow in correlation with trade growth is not borne out factually. The facts present a much more complex picture. If we go back to January 2012, both RMB deposits and Hong Kong and the rolling 12-month level of imports are at nearly the same level today as they were in January 2012. However, during that time while Chinese imports rose as much high as 115 from a 100 base and dropping as low as 91, RMB deposits soared as high as 174 and currently sit at 89, dropping quickly every month.

The general directionality is somewhat similar with a correlation coefficient, as a simple measure of .49, but the RMB deposits proving highly elastic. Furthermore, what is notable is that in recent history, they have been negatively correlated. Since August 2016, imports growth has mostly been moderately to robustly positive with only two months experiencing YoY negative growth. However, during that same time RMB de-globalization has continued apace. Using our figures where January 2012 equals 100, July 2016 imports were equal to 91.59 and March reported a 96.92. During that same time, using the base 100 scale, RMB deposits in Hong Kong dropped from 115.82 to 88.79 in February, the last month we have data for. In other words, just on the simple empirics of the assertion that RMB globalization stopped due to trade weakness, the evidence contradicts this argument.

It may be argued that China opted not to liberalize the RMB in what was effectively a down market. While it may be argued that Beijing opted for this policy course based upon the weak growth in trade, since they did not opt to globalize the RMB when trade was strong, it is difficult to give this argument serious credence for a few specific reasons. First, markets do not always give specific participants the outcomes they want, they give the market the outcome the markets want. Beijing withdrawing their support for a global RMB when the price declines is simply evidence that Beijing does not want a global market priced RMB, but a price and flow dictated by Beijing. They will be happy to let it be "market based" when it does what they want, but kill the market when it does not behave according to their plans.

Second, and this is the crux of the entire problem, the RMB will never be a global currency absent totally free price setting and flow mechanisms. By definition, a global market place will set the price for a global currency. Chinese apologists talk about the RMB but can never explain how a currency becomes global if that currency is a) not diffused throughout the world or b) is diffused throughout and has a price set by an administrative body in Beijing. Simple fact of the matter, as Beijing discovered, even a relatively small amount of RMB in Hong Kong created a "market" price that Beijing did not like and it has moved relatively quickly but very forcefully to quash.

The idea that China has solved the flow problem is simply due to the fact that China has imposed near draconian capital controls which even impact basic trade payments. The idea that Beijing is somehow swept along unable to control due to the whims of global trade whether the RMB becomes a global currency is simply false. It is not borne out by either the data or basic economics. Beijing can choose not to globalize the currency and that is their right, but it is important to note that is their choice.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.