Keith Fitz-Gerald: If you have any illusions, put them aside now. It’s the Yuan’s world – the West is just living in it, or borrowing from it as the case may be.
Demand for the Yuan is growing at such a staggering rate that your financial future will be built upon it.
Admittedly, this is a very tough concept for most people to wrap their minds around. It’s tough to lose “your” spot at the top and it’s even tougher to know you’re losing it and not be able to do anything about it because the leaders who are responsible for maintaining that position don’t understand the end game.
It’s made worse by Washington’s insistence that the dollar is still a weapon when large swathes of the world now believe it’s a liability. It’s exacerbated by Europeans who forget that a sound currency actually requires underlying economic stability. It’s threatened by the latest crop of Japanese bankers who seem determined to print money into oblivion.
Sadly, this is not new. The old guard always fights for the status quo when something different or not well understood like the Yuan comes onto the scene.
The Rise of the Yuan
When you think about it, this isn’t too hard to understand because there’s usually a lot of sharing as trust builds between nations during periods of mutual development. Concurrent economic and intellectual openness promotes new monetary relationships then…BANG!
Suddenly, some become far more equal than others, to borrow a phrase from George Orwell’s allegorical masterpiece,Animal Farm. Very quickly the growth that everybody once enjoyed craters, placing new restrictions on the creativity and wealth needed to sustain it. Absent a logical outlet, the excess energy and economic wealth that would have been previously incorporated into the old system goes somewhere else.
That somewhere else is the Chinese Yuan, and it will be for decades to come. Everything else is just a sideshow.
For example, lately people have been talking in angry terms about the huge piles of cash U.S. corporations hold offshore. Most are frustrated that corporations find it more profitable and less risky to keep it there. They don’t draw the connection between that cash and redirected wealth.
Apple, if you’ve been reading up lately, is the poster child for what I’m talking about. It has over $137 billion in the bank, with some 70%, or $94 billion, being held offshore. They assume it’s all in dollars.
What they don’t realize is that huge chunks of cash are held in other currencies, chief among which is the Yuan. So much so that U.S. and foreign firms already hold four times more Chinese currency than they can invest in that country, as reported by Nick Edwards of Reuters recently.
It’s hardly by coincidence that Yuan-settled trade jumped 41.3% to nearly 3 trillion Yuan in 2012…after it increased by more than 300% in 2011.
The cold, raw reality is that Western demand for Chinese currency is actually fueling the Yuan’srise.
That’s because the perfect storm of punitive taxation, chronic debt, a morass of regulation, and the uncertainty it creates is pushing money away from the United States. Meanwhile, newly punitive problems in the Euro are creating a flight off the continent.
The Yuan, to borrow a tech term, is the new “killer app.”
I use the term differently than Harvard Professor Niall Ferguson, who outlines a similar logic in his fabulous book, Civilization: The West and the Rest, which chronicles the six factors that enabled small European nations to dominate the globe beginning in 1500 — competition, scientific revolution, property rights, medicine, a strong work ethic and consumerism as the agents of change.
To me, it’s the money itself that’s the game-changer. Today, it’s the have-nots that increasingly have it all.
Currencies only work when there are underlying standards, a solid foundation and value. None of the big three have anything remotely resembling these characteristics any longer.
Take the dollar. It’s lost more than 80% of its value since being taken off the gold standard in 1971. Our nation is $222 trillion in the hole according to Yale Professor Lawrence Kotlikoff’s analysis of CBO numbers. Our national debt has skyrocketed to more than $16.652 trillion and is increasing at something like $50,000 a second. Things are so bad that Helicopter Ben is buying $85 billion in paper a month.
The euro is singing only a slightly different tune.
According to the Maastricht Treaty, national public debt is not to exceed 60% for any member state. Yet, at the end of 2011, Greece, Italy, Ireland, Portugal, Belgium, France, UK, Germany, Austria, Cyprus, Spain and Netherlands, all had government debt as a proportion of GDP of 165.63%, 120.1, 108.1%, 107.8%, 98%, 85.8%, 85.7%, 81.2%, 72.2%, 71.6%, 68.5% and 65.2%, respectively.
And finally, Japan’s in deep, too. With total combined private, corporate and government debt near 500% of GDP, the Yen is living on borrowed time. It is, as my good friend John Mauldin and I have discussed many times, a bug in search of a windshield.
But the Yuan has risen 24.66% against the U.S. dollar since June 2005, backed in part by 1.3 billion consumers and real assets.
That’s because strong currencies attract capital, while weak currencies shed it. Money, when you get right down to it, is self-regulating no matter how much the politicians and central bankers try to create the illusion that they’re in control.
It’s also self-reinforcing. Simply put, the more people – investors, bankers, traders, etc. – that participate, the stronger a currency becomes and the bigger the gains are from increased trading activity and capital attraction.
This “killer app” effect is further reinforced by trading networks that spawn via the enhanced reputation that comes with everything I’ve just mentioned. Trade begins with fringe nations settling in small amounts for bilateral trade.
Then it moves upstream. Initially, this involves fringe parties but ultimately major players are sucked in, too, because the cost of not participating becomes too high to bear.
And, finally, exchanges are built that allow free trade to flourish and new partners to enter the “network” that’s been built. The irony is that early adopters flourish while the late-comers find themselves at a distinct disadvantage.
You Can’t Fight the Yuan
That’s about where we are today with the Yuan.
From very humble beginnings, China‘s quietly built up more than 18 swap agreements. In fact, HSBC forecast (in 2010) at least half of all trade with emerging markets could be settled in Yuan by 2013- 2015, which would be up from only 3% in 2010.
HSBC also sees nearly $2 trillion worth of trade flows that could be settled in Yuan annually, which would make it one of the top three global trading currencies and one that is totally outside of existing currency trading pairs.
Formerly just the domain of fringe players in small emerging markets, now Australia, Russia, Brazil, India, South Korea and South Korea all have some sort of bi-lateral agreements in place with the Yuan – and both Germany and England are now contemplating joining the party in earnest.
Ultimately, the United States will too, but they better get a move on it in Washington.
China’s making ready to trade the Yuan freely by 2015 from London of all places. That means in less than two years the world will have another currency to contend with.
Only this one has been built from the ground up entirely by design. This is not by accident. China picked London because it’s served as a financial hub for centuries. It’s also payback for Hong Kong and the opium wars.
At the end of the day, you can fight this all you want.
But understand the Yuan has only just begun to grow – as an exchange mechanism, as a cultural influence, and as a trading tour de force.
The way I see things, the Dragon is coming to lunch in two years’ time. The only decision you have to make is whether you want to be at the table or on the menu.
How to Capitalize on Chaos
Individual investors can make the Yuan a part of their investing future in several ways:
1) Invest in the “glocals” I talk about so frequently. These are companies like General Electric (NYSE:GE), ABB Ltd (NYSE:ABB) and McDonalds Corporation (NYSE:MCD) with global brands and a highly localized presence. They typically have fortress-like balance sheets, experienced management and, most importantly, huge percentages of their revenues coming from global markets growing at 3-5 times the speed of our own. They’re the ones accumulating the Yuan, so it only makes sense to build upon the economic power base that represents.
2) Buy an ETF like the Wisdom Tree Dreyfus Chinese Yuan ETF (NYSEARCA:CYB). At a time when Washington has been busy trying to convince the public that China’s Yuan is being held down artificially, it’s actually appreciated by 24.66% against the U.S. dollar since June 2005. I think it will rise significantly when the Chinese ultimately unblock it because of the pent-up demand being fostered now…when nobody’s looking.
3) Open an EverBank Chinese Renminbi World Currency Access Deposit account. It’s IRA eligible, FDIC insured, there are no monthly account fees – and you can open an account for as little as $10,000.
4) Open a deposit account directly with the Bank of China, Ltd., which began offering Yuan-based deposits, exchange remittance, and trade financing a few years back. Transactions are limited to a few thousand dollars at a time and you have to visit the branch in person in Los Angeles or New York to get started. Savings accounts require a balance of $5,000, but demand-based deposit accounts carry a $3,000 minimum.
Here’s one last thing to consider…
Every time we’ve seen a major revolution – The Age of Navigation, The Industrial Age, the Computing Age – the world has entered into a new golden age of investing. Just as we will when the Age of Deleveraging grinds to a halt.
All the right drivers are there… they just happen to be on somebody else’s roads this time around.