Dol­lar, not yuan, poses big­gest risk to world

... the Bank for In­ter­na­tional Set­tle­ments re­ported that the US dol­lar has re­placed the volatil­ity in­dex as the new fear in­dex ... It is not the ren­minbi but the US dol­lar that to­day poses the greatest risk to the global econ­omy and serves as its fear gau

China Daily (USA) - - VIEW -

Re­cently, the Chi­nese cur­rency fell to its low­est level since late 2008. The ren­minbi has been trad­ing around 6.89 to theUS dol­lar. The plunge is typ­i­cally ex­plained with the an­tic­i­pat­edUS Fed­eral Re­serve rate in­crease in De­cem­ber and pres­i­dent-elect Don­ald Trump’s threat to la­bel China a cur­rency ma­nip­u­la­tor and slap tar­iffs on Chi­nese ex­ports.

In re­al­ity, there is much more to the story.

In the long term, China’s growth will trans­late to cur­rency power in for­eign-ex­change mar­kets. In Oc­to­ber, the ren­minbi of­fi­cially joined the In­ter­na­tional Mone­tary Fund’s cur­rency re­serve bas­ket, known as Spe­cial Draw­ing Rights. In the com­ing decade, the ren­minbi will ex­pand rapidly through the IMF re­serve bas­ket, the al­lo­ca­tions of cen­tral banks, and those of public, pri­vate, sov­er­eign and in­di­vid­ual in­vestors.

Af­ter sum­mer, the ren­minbi’s fun­da­men­tals im­proved thanks to pos­i­tive spillover ef­fects from over­ca­pac­ity re­duc­tion, fis­cal stim­u­lus and a boost to ex­port com­pet­i­tive­ness, due to weaker ex­change rate.

In the fourth quar­ter, the Chi­nese cur­rency will also feel the ad­verse im­pact of a mild cor­rec­tion of prop­erty prices.

The ren­minbi’s short-term volatil­ity is also com­pounded by the tu­mul­tuous global en­vi­ron­ment and theUS dol­lar. Along with other emerg­ing mar­ket cur­ren­cies, the ren­minbi must cope with the US dol­lar, which re­cently hit a 14-year high, driven by ris­ingUS bond yields, ex­pec­ta­tions of a Trump fis­cal stim­u­lus and the im­pend­ing Fed rate hike. In the process, other Asian cur­ren­cies— the Ja­panese yen, In­dian ru­pees, Korean won, In­done­sian ru­piah and theMalaysian ring­git— suf­fered a sell-off.

In the long term, the spillovers from the US and Chi­nese fi­nan­cial mar­kets are likely to have a dif­fer­ent im­pact on fi­nan­cial mar­kets in the Asia-Pa­cific re­gion. Stud­ies con­ducted by cen­tral banks sug­gest that in nor­mal times China’s in­flu­ence in the eq­uity has risen close to the US’ level, al­though the rel­a­tive im­pact of the US has been stronger dur­ing cri­sis pe­ri­ods.

The in­flu­ence of China is based on a re­gional pull, while that of theUS re­flects a global push. The cur­rent cri­sis fa­vors the dol­lar, but over time sta­bil­ity will sup­port the ren­minbi.

Un­for­tu­nately, the ren­minbi, along with other emerg­ing mar­ket cur­ren­cies, must also cope with the dol­lar’s grow­ing risk in the world econ­omy. Be­fore the 2008-09 global fi­nan­cial cri­sis struck, there was a close cor­re­la­tion be­tween lever­age and the volatil­ity in­dex (VIX). When the VIX was low, the ap­petite for bor­row­ing went up, and vice-versa. That cor­re­la­tion no longer pre­vails, due to years of ul­tra-low rates and rounds of quan­ti­ta­tive eas­ing by ad­vanced economies’ cen­tral banks.

Re­cently, the Bank for In­ter­na­tional Set­tle­ments re­ported that theUS dol­lar has re­placed the volatil­ity in­dex as the newfear in­dex. As the VIX’s pre­dic­tive power has di­min­ished, the dol­lar has be­come the in­di­ca­tor of risk ap­petite and lever­age. This dy­namic has dis­tress­ing im­pli­ca­tions, be­cause it has pushed in­ter­na­tional bor­row­ers and in­vestors to­ward the dol­lar.

And yet, as the dol­lar’s ap­pre­ci­a­tion is ex­pos­ing bor­row­ers and lenders to val­u­a­tion changes, the US’ fun­da­men­tals are erod­ing, as pres­i­dent-elect Trump him­self has ac­knowl­edged. TheUS’ sov­er­eign debt has soared to $19.9 tril­lion. And in the past year, for­eign cen­tral banks sold al­most $375 bil­lion inUS Trea­suries.

In these con­di­tions, the Fed rate hikes could boost theUS dol­lar as a kind of global Fed funds rate, which would re­sult in dol­lar tight­en­ing and de­fla­tion­ary con­straints— which, in turn, could im­pair emerg­ing economies that to­day fuel global growth prospects.

It is not the ren­minbi but the US dol­lar that to­day poses the greatest risk to the global econ­omy and serves as its fear gauge. The au­thor is the founder of Dif­fer­ence Group and has served as re­search di­rec­tor at the In­dia, China and Amer­ica In­sti­tute (USA) and vis­it­ing fel­low at the Shang­hai In­sti­tutes for In­ter­na­tional Stud­ies (China) and the EU Cen­ter (Sin­ga­pore).

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