atp’s posterous

--- ok, ok, j'achète. j'espère que je ne ferai pas bouger le marché du remnibi! http://www.gavekal.com ---

The usual suspects come to mind in regards to yesterday's US$ sell-off: 1) risk appetite is increasing; 2) the US$ carry-trade is being revived, as exemplified by a number of US$ fundraisings by emerging market companies (e.g., Vale's $1bn bond issue-see here), and 3) the (in our mind overplayed) worry that the Fed is debasing the dollar. Besides these explanations, however, there may be another major force behind yesterday's move-in a word, China. As we have mentioned in numerous reports this year (see The Return of Financial Sector Reform or The Policy Decisions That Matter Will Take Place in Asia), Beijing is undertaking a series of financial-sector reforms that will, ultimately, allow the country to accrue "capital productivity" gains. This process has been hastened by the global collapse in demand, because China recognizes that they need to replace the labor productivity gains that the export industry has offered over the past decades (workers moving from the field to the factory; imported technologies and management skills spreading from export sector to the broader economy, etc.). However, China cannot pull off financial sector reform while also denying its banks the experience that comes with international dealings. Thus we are also seeing increased capital-account liberalization, which in turn will subject the country's currency to greater market forces. That implies a strong a stronger Renminbi, and (as the market seems to fear) less demand for US$-denominated assets. This is a long-term, ongoing story, but in the past week the newsflow out of China has come thick and fast, while at the same time the Yuan is rising, hitting a four-month high. Consider just a few examples of recent headlines:

1) China increased the individual quota for foreign institutional investors into the A-share market: This move, coming on the heels of the A-share sell-off in August, sent a signal that China is supporting the stock market, and has no desire to withdraw liquidity from the system.

2) China Development Bank sets up a Rmb35bn private equity vehicle: Meanwhile, the head of Google China resigned to set up his own technology-focused private-equity vehicle, having collected funds from big names in global tech. These are on-the-ground reminders of growing momentum in China's financial sector.

3) Beijing to issue a Rmb6bn sovereign bond issue - in Hong Kong: This move is a follow-up on China's recent decision to anoint Hong Kong as the first off-shore center for Renminbi bonds. This will deepen the offshore bond market, provide a benchmark for issuers and may help to spur a more mature corporate bond market. Overall, it is yet another important step for the internationalization of the Chinese currency.

The issuance of an offshore sovereign bond has particularly caught investors' eye, because some see this as confirmation of a China plot to unseat the US$ as the world's reserve currency. But here we beg to differ. The US$'s status as the world's currency is not actually under siege, by China or anyone else (see Arthur's ad hoc here). China will not be fully opening its capital account in the next five minutes! The story here is a long-term, gradual one. But there is increasing evidence that China is committed to an external rebalancing and a reduction of the current account surplus. As a result, the Chinese currency will strengthen against the US$ over time-and big "China newsflow weeks," as we have seen in the past fortnight, serve to wake investors up to this reality. Nevertheless, just because China is busy reforming its financial sector, it does not automatically mean that the dollar will have to go to zero, especially against other currencies than the RMB.