We’re on the verge of one of the most extraordinary financial revolutions of our lifetimes.
According to HSBC bank’s chief economist, Qu Hongbin, it’s a revolution of “truly epic proportions.”
And it’s one that could have major implications for international investors.
I’m talking about the rise of the “redback.”
Everyone has heard of the “greenback.” It’s the nickname given to the paper money the Union Government issued in 1862 to fund the Civil War.
Today, greenbacks enjoy special status. The U.S. dollar is world’s “reserve currency.” This means it’s held around the world as part of governments’ foreign exchange reserves.
The dollar’s reserve currency status allows the U.S. to buy commodities—which are priced in dollars—at a lower rate than other nations. (Non dollar-based countries must first exchange their local currencies to dollars, which incurs transaction fees.)
And it keeps the dollar stronger versus other major currencies than it would otherwise be, as there is always a strong market for dollars.
This is key. Because it’s this strong market that allows Washington to keep on borrowing out of an empty pocket at relatively low interest rates.
On the other side of the picture is the “redback”—the Chinese yuan. What’s officially known as the renminbi.
So far, the yuan has been the polar opposite of the dollar.
Although China is the world’s second largest economy, the yuan doesn’t float freely against other currencies. Instead, Beijing keeps a tight control on the yuan, pegging to the U.S. dollar through direct intervention in the currency markets.
But that is changing. And it’s changing fast.
While most investors fret about the fate dollar and the euro, Beijing is taking significant steps to internationalize the yuan.
For instance, Beijing recently opened up yuan-dominated financial markets in Hong Kong. Now international companies—and even foreign central banks—can buy so-called “dim sum” bonds: debt issued in yuan in Hong Kong.
And big U.S. blue chips such as McDonald’s (NYSE:MCD) and Caterpillar (NYSE:CAT) have issued corporate debt in yuan in the “dim sum” market.
This matters. Because it means these companies…and the investment houses and foreign central banks that are buying up “dim sum” bonds…are placing big bets that the yuan will be worth a lot more versus the dollar over the coming months and years.
You see, right now powerful forces are pushing China’s leadership to open up the yuan to the rest of the world.
Why China Can’t Afford to NOT Let the Yuan Rise
The rate of inflation right now in China is about 5%. But if that figure climbs higher, China’s leaders know it has the potential to cause dangerous economic destabilization… and even social unrest.
Another headache for the Chinese leadership is the bubble in property prices—particularly in Beijing.
A higher yuan would help let some air out of the Chinese economy by lowering export growth. And this would help bring down inflation.
The yuan stands at a 17% high versus the dollar right now. And I believe we could see an even faster appreciation in 2011 than the mainstream media is expecting. In fact, it’s very possible we’ll see the Chinese leadership actively revalue the yuan upward this year.
And regardless of how fast the yuan rises versus the dollar, I firmly believe that the only way from here is UP. China simply has too much at stake to do otherwise.
That makes a rising yuan one of the closest things to a one-way bet you’re likely to see all year.