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The new world monetary order continued to evolve with two separate developments Tuesday.
Japan said it would join China in buying debt securities to support beleaguered European sovereign creditors. In so doing, the world's No. 2 and No. 3 economies were acting to try to hold together the euro as a viable alternative to the world's reserve currency, the dollar, from the No. 1 economy, the U.S.
At the same time, China permitted trading of the renminbi in the U.S. for the first time -- a significant step in the RMB becoming a full-fledged international, convertible currency.
To be sure, steps taken by both Japan and China are being motivated by their own considerations. But they are both part of the loosening of the global monetary system away from its dollar-centric mooring.
In Tokyo, Finance Yoshihiko Noda said Japan would buy more 20% of a debt offering by the European Financial Stability Facility, the €440 billion ($572 billion) bailout fund established last June by the European Union. The financing is expected sometime this month.
That follows the previous announcement by Chinese authorities that they would buy bonds of Greece, Spain and Portugal directly to support those hard-hit debtor nations.
"Normally, it would be considered a pretty sick joke: Japan, the world's largest debtor by a mile, riding to the rescue of eurozone debt? C'mon now!" comments Uwe Parpart, Cantor Fitzgerald's Asia Strategist in his daily missive to clients. "But these are not normal times and if Japan has nothing better to do with its forex reserves than stuffing them into the European sinkhole, why should anyone object?"
Indeed, but Japan and China would prefer to have the euro survive than to be stuck with just the dollar as the sole viable currency for international transactions and as a reserve. What's more the economic impact of a break-up of the euro would hit Europe as a whole, a major trading partner for the export-dependent economies of Japan and China. Thus, the countries no doubt see themselves keeping Europe afloat rather than pouring reserves down a sinkhole.
Meantime, various reports said Portugal was being urged by Germany, France and other core EU countries to accept an aid package along the lines provided to Greece and Ireland. That elicited a denial from Portugal's prime minister that his nation needed a bailout -- also similar to the denials coming Greek and Irish officials last year just before they ended up accepting aid.
In addition, the European Central Bank has been actively buying Portugal debt to counter the wave of selling. Yields had continued to rise in the face of the ECB buying that began last week, but news of Japan's intention to buy bonds of the EFSF, the EU bailout agency, helped bring their yields down and shore up the euro, for now.
So far, the euro won't collapse, if only because of all the government money being put behind, both from Europe and Asia. That may only delay the inevitable -- an outright default by one or more eurozone debtor nations. Before the single currency, overly indebted nations would devalue -- a backdoor default since creditors were repaid in less-valuable currency. Now, the talk is of "haircuts," in which debtors get less than 100 cents on the euro. That is default by any other name.
In essence, Japan and China are buying time. Obviously, their hope is that Greece, Spain, et al, will have a chance to grow out of the debt deflation. Good luck to that.
That also would provide time for an evolution of the monetary system, with the renminbi playing a greater role. The Bank of China, a state-controlled commercial bank, is expanding RMB trading in New York after it was permitted last year in Hong Kong, the Wall Street Journal reports.
This also follows an expansion of RMB dealings directly in other currencies, such as the Russian ruble and Brazilian real. Traditionally, Such "cross trading" typically involved in the exchange of one currency, say RMB, for dollars. Then, those dollar would be exchanged for rubles. This intermediate step is starting to be eliminated, cutting out the middleman of dollar dealings.
Allowing the RMB to be traded may accelerate the appreciation of the Chinese currency, which may work to China's advantage on several fronts.
First, it would help to counter growing inflation, especially for commodities. A stronger RMB would reduce the cost to China of these goods, which are priced in dollars. That may ease pressures on politically sensitive food prices more directly than increases in interest rates and reserve requirements.
A higher RMB also might mollify political criticism. In the U.S., New York Sen. Chuck Schumer is unlikely to be satisfied by a modest increase in China's exchange rate. But Brazilian officials' complaints about the so-called currency wars, which they see as the result of the Federal Reserve's driving down the dollar with its purchases of Treasury securities, have another subtext. While the RMB remains effectively pegged to the USD, a cheaper dollar means a cheaper renminbi, which bedevils Brazilian manufacturers. A higher RMB would ease any friction with Brazil, a critically important trading partner with China.
According to the old Chinese saying, the thousand mile journey starts with a single step. These steps are part of the movement away from dollar hegemony, a journey already begun.
Comments: E-mail randall.forsyth@barrons.com
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