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Insight to All Things Currency and Treasury Management

At 9:00 a.m. Beijing time today, November 8, 2012, the Chinese Community Party’s 18th Congress came to order, beginning the once-in-a-decade process of appointing a new set of leaders for the world’s second largest economy.

Yet all of the international business news headlines on Wednesday were focused on the outcome of the U.S. election, and on Europe (most notably, on Greece’s latest round of austerity measures). That’s the way it has been for the last several months – all eyes on the U.S., all eyes on Europe, and no one’s watching China (not from a currency perspective anyway).

That’s a big mistake, because China is already a central figure in a global currency war. And when the new Party leaders begin a new set of reforms at the end of the Congress next week – reforms likely to include yuan liberalization – that currency war is going to escalate.

To be clear, multinational CEOs have been watching China, but they’ve been watching China’s economy, thinking about the impact of the slowdown there on sales. As a result, CEOs are justifiably nervous. CFOs, though, don’t seem to as aware that China will be the epicenter of the next big currency war, which has already begun. CFOs should be  nervous, too, given that most not as prepared as they could be.

Yuan liberalization is inevitable…

Many observers have assumed that because President Obama was reelected, the U.S. will not label China a currency manipulator (as Republican nominee Mitt Romney had said he would do) – and therefore the China currency concern is alleviated. But while officially labeling China a currency manipulator might cause some political feathers to fly, the currency war centering on the yuan (and drawing in the U.S. dollar, euro, Brazilian real, Japanese yen, and a host of other currencies), will escalate as China allows the yuan to liberalize – which it will do no matter the U.S.’ “official” position.

That’s what we’ll see coming out of the Chinese Community Party’s 18th Congress – liberalization of the yuan and other financial and economic reforms. Reform is not optional in China, and we’ve already seen signs that they’ve begun the process of yuan liberalization. For example:

  • According to the Wall Street Journal, “Canadian steel importer Direct Alloys Inc. is one of a growing number of foreign businesses switching to the yuan to settle trade with China, a trend that is boosting the currency’s global status.”[1]
  • Western Union reports that its U.S. clients increased the number of renminbi payments to China by more than 15 percent in the second quarter of this year compared with the previous quarter.
  • In the last two months, foreign companies have tapped the so-called “dim sum” bond market in Hong Kong, then entered into swap contracts to make money from the lending rate they receive on the yuan.[2]

…And it will be the first shot in an escalation of the global currency war

While a liberalized yuan will, in fact, be a very good thing for the global economy, getting to that point will involve a lot more volatility than we’ve seen with the yuan, and an escalation of the currency war as countries attempt to mitigate the effects on their own currencies.

At that point, of course, the yuan-centered currency war will make the headlines, and CEOs and CFOs will be paying attention. But for the multinationals that haven’t proactively prepared, damage will already have been done – just as was the case with the euro crisis (when top-line effects totaled in the billions in one quarter alone).

Key takeaways

  • While all eyes have been on the West – on the U.S. election and the euro crisis – China has begun the once-in-a-decade process of appointing new leadership. At the end of its 18th Party Congress, China will be on a new path to reform, including currency reform.
  • While positive in the long run, yuan liberalization will increase the volatility of the yuan, and that will lead other countries to manipulate their own currencies to mitigate the effects. In other words, yuan liberalization will escalate the global currency war that has already begun.
  • At that point, all eyes will be on China, but damage will already have been done to MNCs that have been looking the other way.

 

UP NEXT: The Escalating Global Currency War – Unprepared MNCs Will Be Caught in the Crossfire

Increased yuan volatility will escalate the currency war that is already playing out as countries attempt to mitigate the effects on their own currencies. Stay tuned for our next blog post, where we’ll talk about the shots that have already been fired in this currency war, how it will escalate (and why), how it will affect you, and how you can manage the associated risk.

 

 

 


[1] “Yuan Gains Steam in Global Trade,” Wall Street Journal, 10 Oct 2012.

[2] “A New Recipe for Dim Sum,” Wall Street Journal, 17 Oct 2012.