The Emerging Basket of Reserve Currencies

A leading Hong Kong businessman and prominent citizen told me last earlier this week that he fully expects the rise of an offshore renminbi market similar to the offshore euro dollar market that emerged in the 1960s-70s in London. Of course, he expects this renminbi market to be centered in Hong Kong where the renminbi has become a de facto legal tender and a competitor with the U.S. and Hong Kong dollar.

Just in the first quarter of this year renminbi also called yuan deposits rose 72 percent in Hong Kong to nearly $9 billion. People are switching their assets from Hong Kong dollars to yuan because Hong Kong dollar deposts yield almost nothing and the yuan is expected to continue to appreciate versus the Hong Kong and U.S. dollars.

To underscore the emerging regional and global role of the yuan, yesterday’s South China Morning Post reported that the central banks of China and Kyrgyzstan are in final discussions to make the yuan fully convertible into Kyrgyzstan som in order to promote bi-lateral trade and investment. This reflects the increasing use of the yuan to settle trade deals and the increasing desire to use it for investment accounts as well. The Post reported that Mongolia and Vietnam are also turning increasingly to the yuan because of their heavy trade with China and the expectation that the yuan will continue to appreciate steadily.

In discussions today here in Taipei with top banking figures, the expectation was voiced that the yuan and NT dollar will also be made fully convertible by the China Mainland and Taiwan central banks.

Meanwhile after falling back for a time from its record value of $1.60/euro, the euro is surging again as Euroland and particularly Germany seem to be shrugging off the impact of the U.S. downturn and even the impact of soaring oil prices.

Indeed, the truth is that oil is de facto being priced in euros- not dollars. Here’s how it works. The Arab oil producers are paid mostly in dollars. But their imports are mostly from Europe because the United States no longer makes much that anyone wants to buy. The share of oil exporting country imports supplied by Europe and Japan is now over 40 percent as compared to less than 10 percent for the United States. So with the dollar falling like a stone in value, the oil producers are losing their purchasing power in Europe. But not really because they compensate by raising the price of oil.

Of course, a lot of other things are going on as well. But as James Saft notes in the Herald Trib, the European Central Bank has the will, the motivation, and the economic leeway to fight the impact of inflation from rising oil prices while there are doubts about the willingness and ability of the Federal Reserve to fight inflation in the face of a deepening recession. This points to continued weakening of the dollar along with a rising euro and rising oil prices.

Further, Saft notes that whereas in the past, the money earned by oil exporters tended to be kept largely in U.S. Treasury securities, the petro countries have recently begun to diversify outside the dollar through greater euro bond holdings and through the use of sovereign wealth funds that are investing in shares and a variety of commodities and global assets.

Several years ago, a former Undersecretary of State testified before the U.S.-China Council that soaring U.S. current account deficits and the build up of enormous dollar holdings in foreign central banks posed no problem at all. He said: “We have all the high cards.” His argument was that just because the dollar holders had such large stakes, they would lose more than the United States if they made a move out of dollars. It was the old: “If you owe the bank $1,000 you have a problem, but if you owe the bank $1 billion the bank has problem argument.”

Clever and facile, but superficial and ultimately wrong. What the currency and investment flows and stories in the overseas press are telling us is that a new order is emerging in which the euro and the yuan will increasingly displace the dollar as the world’s money. To be sure, the dollar will not disappear overnight. But neither will it maintain its old primacy, and the implications of that for the United States which has been able to live far beyond its means for a very long time because of dollar primacy are immense economically, socially, and geo-politically.