Be­hind the RMB’s strength

Financial Mirror (Cyprus) - - FRONT PAGE - Mar­cuard’s Mar­ket up­date by GaveKal Drago­nomics

When Michael Milken in­vented junk bonds in the early 1980s, few fore­saw that his new mar­ket would change the way com­pa­nies fi­nanced them­selves. Nor did they think it would al­ter how busi­nesses looked at their cost of cap­i­tal, trig­ger an M&A boom, mid­wife the birth of the pri­vate eq­uity in­dus­try or change the way banks were run. How­ever, with hind­sight, it is ob­vi­ous that the cre­ation of junk bonds was one of the most im­por­tant fi­nan­cial de­vel­op­ments of the last 30 years. Yet the majority of in­vestors re­mained obliv­i­ous of the shift for a very long time.

Fast for­ward 35 years and the ques­tion is whether in­vestors are once again in dan­ger of ‘miss­ing the for­est for the trees’. The sin­gle most im­por­tant fi­nan­cial de­vel­op­ment of re­cent years might well be the cre­ation of the Dim Sum bond mar­ket. Yet few in­vestors seem to care. To­day, the world’s sec­ond largest econ­omy and its largest ex­porter is cre­at­ing a new bond mar­ket whose stated pur­pose is to pro­vide an al­ter­na­tive source of fi­nanc­ing for emerg­ing mar­ket com­pa­nies, and to help China break its US dol­lar de­pen­dency and move to­wards fi­nanc­ing trade in its own cur­rency. Things are mov­ing fast: in just four years, China has gone from set­tling none of its trade in ren­minbi to set­tling a quar­ter.

For China to suc­ceed in shift­ing its trade away from US dol­lars and into ren­minbi, it needs three things: a) a sta­ble bond mar­ket (so peo­ple can park ex­cess ren­minbi in yield­gen­er­at­ing in­vest­ments), b) a cred­i­ble cap­i­tal mar­ket (China is lucky as the only emerg­ing mar­ket with a cred­i­ble fi­nan­cial cen­tre-Hong Kong), and c) a strong cur­rency (who wants to save, or keep work­ing cap­i­tal, in In­done­sian ru­piah or Turk­ish lira?).

Which brings us to the re­cent strength of the ren­minbi. While the weak­ness of the euro, yen, pound, and Swiss franc against the US dol­lar have cap­tured in­vestors’ at­ten­tion lately, few have no­ticed that the Chi­nese cur­rency has in turn out­per­formed the US dol­lar, mak­ing all time highs against the yen, and is not far off of its record high against the euro.

One can point to many fac­tors be­hind this strength, but the bot­tom line is that Beijing wants to es­tab­lish the ren­minbi as the trad­ing cur­rency for emerg­ing mar­kets, and will only suc­ceed if the ren­minbi is strong.

At a time when most ma­jor cen­tral banks are keen only to de­base their cur­ren­cies, it is no­table that one cen­tral bank has cho­sen a non-quan­ti­ta­tive eas­ing, non-zero in­ter­est rate pol­icy ap­proach. As we see it, China’s in­ten­tion to in­ter­na­tion­alise its cur­rency means that the ren­minbi and ren­minbi bonds re­main among the best risk-ad­justed stores of value avail­able to in­vestors to­day.

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