Currencies | Nov 18 2014
By Greg Peel for FNArena and Michael Lombardi, MBA, for Profit Confidential
Australia Set To Cut Out The Greenback
By Greg Peel
In recent months the Aussie dollar has retreated from its longstanding highs, including an extended period above parity. In forex circles, “Aussie dollar” means AUDUSD. The lengthy period of post-GFC strength has been blamed for all but killing off Australia’s manufacturing industry and routing the retail industry, just in time for mining investment to peak. The Aussie’s overvaluation has been a direct result of the US Federal Reserve policies of zero interest rates and quantitative easing, ensuring weakness in the greenback and a demand for US carry trading into higher yielding offshore assets.
In 2013 the US was Australia’s fourth major trading partner, at a mere 4.9% of the total. South Korea was third at 7.2%, Japan second at 16.6% and all were blown away by China at 26.2%. Yet trading with all four partners was conducted in US dollars. Why? Because the greenback is recognised as the world’s reserve currency.
There are no rules to suggest Australia must trade with China in US dollars. A “reserve currency” is simply one deemed to be safe by respective trading partners. Yet Australia has continued to suffer the impact of an artificially weakened reserve currency despite fifty percent of trade being switched at the other end into renminbi (yuan), yen or won, having been switched at this end out of Aussie. Those days, however, are numbered.
There has been much talk of Australia’s newly signed Free Trade Agreement with China and its implications, including winners and losers among industry sectors. Not attracting as much attention is the announced plan for the state-owned Bank of China to open a Sydney-based renminbi clearing hub, allowing direct renminbi-Aussie trading between China and Australia, in either direction. And, as a result, cutting the greenback loose.
For a long time the renminbi was pegged to the US dollar, in which case a Chinese currency hub would have made no difference. But slowly Beijing has been loosening its tie to the reserve currency by expanding the allowable exchange rate range in a form of “dirty float”. It is the government’s intention to move to a fully free-floating renminbi once China’s ongoing financial reforms have established a sufficient level of market robustness.
At present, only 4% of China’s global trade is settled in renminbi and only 1% involves an Australian counterpart. The shift to direct renminbi trading will not make a notable difference overnight, but as liquidity slowly builds and the Chinese currency moves further away from its US dollar “peg”, transaction costs will fall and currency spreads will narrow. There will be no more expensive transfers into and out of greenbacks at either end.
What are the implications for our strong relationship with the US? Washington would certainly not be amused, but the Fed has shown scant regard for any other country’s economy in its blind attempt to ensure the US economy is supported by relentless printing of the so-called reserve currency.
Implications for the US dollar itself are more nuanced, given Australia is not the only country to have decided it’s time to cut the greenback loose. Profit Confidential’s Michael Lombardi examines the wider, global picture…
What Canada-China’s Yuan Trade Deal Means For US Dollar
By Michael Lombardi, MBA
As the chart below illustrates, since July of this year, the U.S. dollar has been rallying against other major world currencies.
I, for one, do not expect to see the rally in the U.S. dollar sustained. I believe the U.S. dollar is currently rallying, because other parts in the global economy are doing worse than the U.S. While the U.S. dollar may rise in the short-term, because our central bank stopped printing new paper money and other countries are still printing their currency, in the long run, I see the fundamentals of the greenback tormented.
Let me explain…
Since the Great Recession, some countries started moving away from the U.S. dollar as their reserve currency—and that movement is accelerating.
In recent days, Canada signed an agreement with China where both countries ditched the greenback when it comes to their trade. Going forward, the respective countries will trade with each other in their local currencies—in Canadian dollars and Chinese yuan. This trade deal made Canada the first country in North America to deal trade in yuan. (Source: The Canadian Press, November 8, 2014.)
In the past, when countries around the world would issue bonds, they were often denominated in U.S. dollars. The reason for this was simple: the U.S. dollar was liquid and recognizable throughout the world. This is changing, too.
For the first time, the United Kingdom has issued yuan-dominated bonds. The country issued bonds worth three billion yuan. This is certainly not a big figure (equal to about USD $490 million), but the move is significant, as the U.K. tests the waters for non-U.S. dollar-denominated bonds. (Source: BusinessWeek, October 14, 2014.) As more countries follow the path of Canada, China, and the U.K. and initiate trade or sell bonds in currencies other than the U.S. dollar, this will put pressure on the value of the U.S. dollar.
Please let me be clear: the U.S. dollar will not lose its reserve currency status overnight. It will be a long process. But I believe it will happen for the following reasons: 1) China is getting closer and closer to uprooting the U.S. as the world’s biggest economy; 2) China has most of the gold; 3) the Federal Reserve will be quick to come out with QE4 if the U.S. economy (or stock market) starts to tank; and 4) the U.S. national debt will continue to rise at an accelerated rate.
If we have learned one thing about money from history it is that a paper reserve currency doesn’t remain a reserve currency forever. The U.S. dollar has had its turn as the reserve currency of the world.
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