China Continues To Support Its Currency

Includes: CNY, CYB, FCA, FXI
by: John M. Mason

China continues to support the value of its currency, something some had questioned given the looming trade war between China and the US.

China still wants to have one of the major reserve currencies in the world and is promoting relationships whenever it can as it spreads its influence throughout the world.

The big unknown in this whole battle is how much the US withdrawal from trade agreements and other international relationships is going to provide openings to the Chinese.

The value of the Chinese renminbi has been bumping up close to seven renminbi for one US dollar.

The fear has been that with the Chinese economy showing a slowdown in growth and the trade battle going on between the United States and China, that the Chinese might just throw in the towel and let its currency depreciate.

Now we learn that in October, "China Spends $32 Billion to Protect Renminbi."

"China spent roughly $32 billion in foreign exchange reserves to strengthen the renminbi in October, its heaviest monthly intervention in nearly two years in the latest sign of Beijing's nervousness about the economy."

"The data released…eased worries that Beijing intended to deploy exchange-rate devaluation as a weapon in its trade war with the US."

Yes, China and the United States are on the verge of an all-out trade war, but, China still wants its currency to remain a trusted reserve currency along with the US dollar, the euro, the British pound and the Japanese yen.

This is the long-run goal and China prides itself in the way it works to achieve long-term goals.

The battle is going to be a long one, but, China believes that its currency must be a real player in the world, it is going to have to have one of the strongest reserve currencies in the world, even, eventually the world's strongest reserve currencies in the world.

However, it is just at the beginning of this path.

We read in the Financial Times, "The renminbi accounted for a paltry 1.84 percent of global central bank reserves in mid-2018."

"This could change as the Belt and Road Initiative expands-it would be easier for all countries in the project to use the same currency. But the renminbi has a long way to go. It is not freely floating, monetary policy is unpredictable and China's economy and financial system are not open."

Still, China has set out its goals and when once adopted, keeps them in sight, even if they deviate from them in the shorter-run.

The looming problem in the short-run is the possibility that the US and China "decouple" because of the tariff battle currently going on.

China's president Xi Jinping is taking a strong position on these tariff battles and recently lashed out at "law of the jungle" trade practices, an apparent attack on the zero-sum approach of US president Donald Trump to forthcoming tariff talks.

Henry Paulson, former US Secretary of the Treasury, takes a dim view of this possible split.

Whereas, Mr. Trump seems to take everything as just a bilateral relationship, Mr. Paulson warns that "The US and China are not, in fact, a couple. There are more than two players here. What if other especially in Asia don't want to follow suit?"

Mr. Paulson goes on, "No country will cut itself off from such a large and rapidly growing economy as China."

"In other words, if forced to choose, many countries will choose China, leaving the US as the isolated one."

And, if such a scenario develops, what will be the currency used in the "new" relationships?

Besides the Belt and Road Initiative mentioned above, we read in the Wall Street Journal that "Beijing is constructing parallel financial and commercial networks across Central and Eastern Europe to challenge the global order."

And, there are many others. China is backing up its talk that it is now the leader of globalization in the world.

Mr. Trump may focus on one-on-one relationships when it comes to negotiating deals, but others…China…have a different strategy. China has taken up the mantle of world leader in trade. It wants to work with others.

And, if China is working with these "others" in what currency do you think that they want to cut their deals.

If China wants its share in global central bank reserves to go up, it must build up trust that it will play by the rules. So, what it does visa-vie the United States must take into consideration what it needs to become a stronger reserve currency.

It will not hurt China to play the card that the United States is busting up all these deals and imposing all these tariffs, while China is working hard to establish and maintain relationships and supports a more connected world, in the trade of goods and services as well as in financial markets.

Such a move, however, will not dethrone "King Dollar". Megan Greene reports in the Financial Times that the dollar's global share of central bank reserves fell to a five-year low of 62.3 percent in the second quarter.

But, Ms. Greene writes that the dollar will not be dethroned in the near future because "there is no alternative."

China, as w re saw, is way back in the pack.

The other major alternative is the euro, but even though the euro has the second-largest share in global central bank reserves at mid-2018, there is a question about the eurozone's survival, "most recently prompted by the Italian government flouting fiscal rules." See, "Italy's Recipe for Another Eurozone Financial Crisis."

The biggest fear, according to the historian Niall Ferguson, the breakdown in US/China relations along with a major slowdown in China's rate of economic growth. This would not only be bad for the biggest corporations in the world, but with the current "out-of-control" fiscal situation in the United States, the problem could "get serious relatively quickly."

China, in terms of its currency moves, seems to be playing the game according to the rules right now. I believe that it is very important for them to establish the presence of the renminbi as a major reserve currency. The currency strength plays well with the role China is taking in globalization, something Mr. Trump seems to be letting them do. But, how much a trade war combined with Trump's lack of fiscal discipline might upset this situation is hard to see. It would be, I think, really too bad if all this led to a decoupling of the US/China relationship.

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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.