U.S. Dollar Firm While Yuan Slides

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Includes: CNY, CYB, FXCH, UDN, USDU, UUP
by: WWS Swiss Financial Consulting SA
Summary

The US dollar is still the primary global reserve currency despite the efforts of some countries to promote other currencies.

The US dollar is holding up well in forex markets. Buying renminbi now is not a good idea as it could go lower if the PBoC wants it to.

The future of the US dollar is uncertain.

The lack of a trade deal with China has been making investors nervous.

Investing in China now is risky for US investors.

There is no doubt that the US dollar is currently the most important global reserve currency with approximately 60% of central bank reserves denominated in US dollars. The fact that the dollar figures in the balance sheets of central banks as reserves means that the demand for dollars remains high, and that helps to support dollar strength. See the chart below.

https://wolfstreet.com/wp-content/uploads/2019/04/Global-Reserve-Currencies-USD-share-annual-2018-Q4-.png

The US dollar is also the most important currency in forex markets with about 85% of all transactions involving dollars. The table below refers to March 2018. The most important currencies in international transactions after the US dollar are the euro, the Japanese yen, and the British pound. The renminbi has a long way to go before it can be considered a major reserve currency.

Currency

Market Share

USD

87.6%

EUR

31.3%

JPY

21.6.3%

GBP

12.8%

The Bloomberg US dollar index chart below shows that the dollar has been holding steady at around 95 most of the time since 2015. This may be due mainly to weakness in the euro as the euro is the principal currency basis for the dollar index. The US dollar has been doing very well against the renminbi. See below.

As investors know rather well, past performance is no guarantee of future performance. That is also applicable to the US dollar. We do not know what is going to happen in the forex markets. There have been several articles about the plans of China and Russia to avoid using the US dollar for payments. It is also the case that countries being targeted by the US, namely, Cuba, Iran, North Korea, Syria, Turkey, and Venezuela are seeking ways to escape from having to resort to dollars for international payments. Saudi Arabia has even threatened to modify its petrodollar policy, which requires customers acquiring its oil to pay in US dollars. There is now an oil futures market in Shanghai, where the Chinese are trying to promote the renminbi for oil transactions. Furthermore, it has now become obvious that President Trump uses the predominant position of the dollar as a weapon in global diplomacy as the US has done in the past. It is thus highly uncertain what is going to happen with the US dollar as a global reserve currency and as the principal currency in forex transactions.

The current trade negotiations between China and the US have so far not reached any immediate far-reaching conclusions besides the imposition of tariffs on large quantities of goods. It is not clear for how long these tariffs are going to remain in force. The MSM and alternative media are full of articles commenting on the negotiations. It seems that President Trump has not been able to make a deal with the Chinese negotiators, so he has upped the ante by imposing higher tariffs on the goods already subject to tariffs, raising the tariff rate from 10% to 25%. It is obvious that President Trump has underestimated the determination of the Chinese not to lose face. Dealing with Chinese is different from dealing with Americans. President Trump is going to learn a lesson about making a deal with Asians, and it is going to be a costly one.

The five-year Bloomberg chart below shows the US dollar exchange rate with the Chinese yuan. It is useful to track the exchange rate because, until well into 2015, a US dollar could buy only ¥ 6.20. The Chinese government was keeping the currency within a narrow range. This began to change in the latter half of 2015 as the dollar strengthened against the yuan. That means that the yuan was weakening against the dollar as, by 2017, a dollar could buy ¥ 6.80. China was exposed to the complaint that the currency was being devalued in order to promote Chinese trade. In the latter half of 2017, President Trump began proposing tariffs on Chinese goods, and this was positive for the yuan, which went to around 6.30 by the beginning of 2018 as it seemed that a deal could be reached. As the negotiations became longer and longer, the yuan weakened as tariffs were imposed, and the dollar went up to more than ¥ 6.80. In this way, the imposition of tariffs had, as a result, a weakening of the yuan, which, to a certain extent, nullified the effect of the tariffs on Chinese imports to the US. Positive news about the possibility of reaching a deal helped to strengthen the renminbi, but recent developments that have been marked by more tariffs being imposed and the unlikelihood of a deal being reached anytime soon have resulted again in weakness on the part of the Chinese currency.

The bottom line for investors is that stock markets may suffer from trade disruptions due to the dispute. Volatility will likely return to the markets. The PPT (Plunge Protection Team) may be sent in to avoid a bear market in the US, given that the current economic cycle is in its late stages. Investments in renminbi are consequently now riskier than before since a breakdown in negotiations may result in a downturn in Chinese markets even if the government intervenes to help buoy up the markets. Recent volatility in Shanghai may presage even more negative downturns that the government will try to counter. Complacent investors may be unpleasantly surprised at future developments. US investors face various risks if they decide to invest in China at this time.

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.