RMB-Yen currency swap starts June 2012

At the 4th BRICS summit, the member countries agreed to work towards currency swaps when trading among themselves. For China, this is a general trend in recent years to internationalizing the renmingbi (RMB) or yuan. At the end of 2011, 9% of China’s total trade were settled in yuan with 14 countries and regions. That’s quite a jump considering in 2010, the percentage was only 0.7! In anticipation of more agreements to come, a report by the HSBC in 2010 estimated half of China’s trade with emerging market countries by 2015 would be conducted using swaps. In other words, the report went on, “nearly USD 2 trillion worth of trade flows could be settled in renminbi annually, making it one of the top three global trading currencies.” Imagine that happening without the yuan floating. Japan and China just announced their swap agreement likely to take effect next month. As a matter of practicality, the two countries will shave $3 billion in commissions alone. What’s the political implication?

Some may view this as a duel between the yuan and the USD. However, I think the broader trend is a global movement towards currency swaps to bypass the USD in situations where the USD brings no added value. Given the relative stability of the U.S. and her might, the USD is still the dominant reserve currency for the foreseeable future.

The 2008 financial crisis brought on by the subprime mortgage crisis and then the subsequent quantitative easing has left many countries realizing the risk involved in holding USD. This includes the Europeans who believe austerity is the right solution while America’s QE1 and QE2 in fact undermines what they want to do. Japan was lashed in the U.S. press for intervening to stop a rapid rise of the Yen due to QE1 and QE2.

By the way, QE1 and QE2 are just fancy words for printing money out of thin air. (Okay, with some strings attached in how that money is spent. But, effectively, its printing money.) The FED has printed about 2 trillion dollars, and in the process diluted USD holders of their wealth. In the last few years, the USD has fallen by 20+%.

In few decades time, we will look back at this year perhaps as the year when currency swaps took off.

That has far-reaching implications, especially as far as American financial dominance goes.

First of all, the world economy would be de-linked from U.S. monetary policy. The FED raising or lowering interest rates or changing money supply would not have the rippling effects throughout the world as they do today.

U.S. financial institutions would play a smaller role in the global economy, as fewer trade transactions would require their intermediary.

For countries which are economically sanctioned by America, presumably would have a much harder time earning USD, would now have an easier time buying and selling goods in their native and trade partners’ currencies.

Currency swaps still require bilateral agreements today, but with practice and volume, it is conceivable that such practice becomes transactional.

It is worthwhile to remember that at the end of WW2, the industrialized nations wanted a global reserve currency. As we know, the USD became that defacto currency. However, different nations at that time envisioned a basket of currencies as the reserve.

Perhaps the pendulum is swinging away from the USD and towards that basket. These next couple of decades will be interesting to watch. Currency swaps may gain critical mass and create the necessary conditions for no particular currency to dominate.

As to American politician and media’s claim of China ‘manipulating’ her currency? Just look at QE1 and QE2. But, that’s missing the point entirely. The big elephant in the room is what’s happening to the USD in global trade.