It did not get a lot of attention (other than H&H), but there were two very significant plays by our bigger mining companies last week. Fortescue Metals announced it would be looking at raising Dim Sum bonds, i.e. debt denominated in yuan, and would sell in yuan. This would remove currency risk and reduce transactional costs. Rio Tinto followed suit . BHP may not be long behind. This is another step in the eventual establishment of the yuan as an alternative to the greenback and the Euro. And in a week in which the Europeans have once again kicked the can down the street and the US squabbles about its debt, it is worth speculating about what the currency regime is developing into.
The likelihood is that there will be a troika by the end of the decade, assuming Europe can make the structural changes it needs to make, some of which were outlined by Greek economist Yanis Varoufakis on Lateline last night:
Very simply, within a few days. Let me outline three steps that we could take in Europe and solve the problem very, very quickly.
The first thing we need to do is unify the banking sector. It is preposterous to have European banks, global banks, that are subject to supervision by member states that don’t have their own currencies. It’s preposterous to have France responsible for the French banks, it’s like having Tasmania responsible for the banks that operate in Tasmania or having Wall Street supervised and recapitalised in times of crisis by the state of New York. You can imagine what catastrophe would befall Australia or the United States if that happened. So, the first thing we could do is unify the banking system, supervision and recapitalisation.
The second thing we need to do is we need a common bond. Something like the US Treasury Bills, something like the Australian Government Bond, Federal Government Bonds; Eurobonds in other words. Eurobonds would allow us to unify part of the debt of each member state and therefore to restructure it in its entirety and make it manageable.
And the third thing we need is an investment policy which is European wide. Something like a Marshall Plan, not for Greece, that they agreed to yesterday, but it is ridiculous to have a Marshall Plan of Greece which is unfunded, which means effectively that monies will be taken out of Ireland, restructure of funds for Ireland and Portugal and Italy, to be redirected and reach out towards Greece.
If you have a Eurobond, at the European level, you could co-finance a Marshal Plan for the whole of Europe using the European Investment Bank, which is twice the size of the World Bank, and thus create a growth drive, spurt, that drives the whole of the Eurozone out of the mire of the present crisis.
The debate in the US over the debt ceiling is all hot air and politicking. About $US4 trillion is transacted per day in the foreign exchange markets. There is no shortage of demand for US dollars; America still has a free pass on issuing debt.
So assuming that the yuan is fully floated in 5 years, and that there has been a gradual transition to making the yuan an international currency in the next few years, what does it look like? I think a few comments can be made. One, the US will not get as much of a free pass at it does the moment. There will be the possibility of significant foreign exchange between China and Europe (an overwhelming reason why Europe will keep its currency intact, in my view). This will at least clip the wings of the American empire and introduce it to sovereign risk for the first time since the Second World War. That would probably have military consequences given that the US accounts for about half the world’s defence spending.
One view is that it would probably mean that, especially in America, the consequences of profligacy would be punished more readily, imposing more economic rationality in relation to the “fundamentals” of spending, borrowing and investing. Governments would have to behave more rationally if they were to be penalised by the international capital markets (not that the prospect of being penalised stopped Latin America in the 1980s, for instance).
But look a little closer to what is happening in the international capital markets and the view is less encouraging. More than half foreign exchange turnover is high frequency trading, up from only 2% in 2004. High frequency trading is starting to dominate global debt, foreign exchange and futures markets.
That does not lend itself to greater “rationality”. It is algorithms chasing algorithms chasing algorithms. Lots of rational mathematical formulae, but not a thinking, rational, mind in sight. On the surface a three way global currency system seems more stable. But not if the geeks are allowed to run loose.