Trash for Treasure: CenBanks Swapping $ for RMB

The old saying goes "one man's trash may be another man's treasure." To be sure, there are any number of countries around the world that would welcome even dollar foreign exchange reserve assets. Think of Egypt. The happy-sad fact though is that, in part because of international currency war being waged by the United States, several developing nations now have more than adequate reserve holdings going by traditional metrics such as number of months' cover for imports or short-term liabilities (sovereign debt and suchlike maturing within a year). If the latter is the case, you may have a problem of holding excessive dastardly dollar-denominated detritus whose ultimate direction is known to all--downhill from here, baby. This situation calls for a move away from the dollar.

What sort of portfolio diversification in terms of currency holdings is desirable, though? The Euro is remarkably resilient despite the woes of its certain member countries largely due to the ECB's inherent fear of inflation inherited from the Bundesbank. It has, in other words, an appreciating bias especially compared to the dollar. Japanese yen meanwhile yield next to nothing even in this day and age of near-universal zero-interest rate policy among industrialized economies. The pound is nowhere near the value it used to be prior to the financial crisis, and the Swiss franc is not quite as readily traded as some of the currencies mentioned above.

Increasingly, then, the Chinese renminbi is finding favour since its rates of return for yuan-denominated instruments are rather different .There is also the practical matter of the yuan being more convenient not only as a store of value but as a medium of exchange as more and more global trade is being conducted in this currency:

[T]here is little argument about the direction of travel..."The way central banks look at calculating reserves is based on trade balances, so as trade with China grows, they will want to hold more and more renminbi."

Gary Smith of BNP Paribas estimates that the emergence of the yuan as a legitimate reserve asset will nt be long in coming as bandwagoning effect takes hold: "My estimate of central bank holdings (of yuan now) is 0.5 percent or perhaps even less. My estimate of where we're going to is over 10 percent over the next 3 or 4 years," he said, adding that the uncertainty was timing, not percentage...

BNP Paribas' Smith bases his forecasts on discussions with central banks he wished to keep confidential, steps taken by China to facilitate foreign central banks' yuan investments and on the fact that private sector payments in renminbi are growing fast. "A lot of central banks hold some renminbi now, all of them in very very small amounts. Every single one will hold more at the end of the year than they do today," he said. This, he said, will in turn push central banks to hold more of the currency. 

Lastly, LDCs are themselves clamouring for more RMB. I am sure it's flattering to China that others want more of what it has tried to keep to itself before. Actually, the lifting of limits on foreign investment schemes already underway may help facilitate (non-official) accumulation of RMB assets:

Countries including Indonesia have publicly announced that they are buying bonds on China's interbank market. Nigeria has also said it wants to make the yuan a reserve currency. Sovereign wealth funds and central banks have also noted Beijing's decision just before year-end to remove a $1 billion limit for them to buy Chinese assets through its Qualified Institutional Investor Programme.

So far, the only officially sanctioned accumulation of yuan for reserve purposes was that by Japan right before Sino-Japanese relations went awry over a bunch of rocks in the sea. Yet "We want yuan!"is increasingly the new battle cry for central bankers from Jakarta to Lagos.

I sure don't see anyone clamouring for more dollars. There is a moral to the story somewhere in here.