The Long-Anticipated Dollar Depreciation

Economics, Premium POM

Foreign Selling of US Treasuries Most Since 1978

By JC Collins

It’s not a coincidence that the People’s Bank of China officially stated a few months ago that they would further open their domestic bond market to qualified foreign institutional investors.  This would include commercial banks, pension funds, and other financial institutions. The announcement came the day before the G20 meetings in Shanghai and marks another transition point for the multilateral monetary framework.

It is now being reported that the foreign selling of US Treasuries in the month of April has been the highest since 1978.  That is a substantial statistic which warrants further consideration.  The outflow in April was $76.4 billion.

Back in February China approved $80.8 billion for Qualified Foreign Institutional Investors.  The selling of US Treasuries in April aligns with the PBoC’s approved RQFII amount announced a few months before.  But making a firm connection between both would require more hard facts and numbers.

As I reported yesterday, an unnamed American bank will be investing in 250 billion Chinese renminbi:

One of the biggest financial news stories which has gone unmentioned over the last week is the official remarks released by Chinese Vice Premier Wang Yang at the end of the Eighth Economic Track of the US-China Strategic and Economic Dialogue, which stated the following:

“The two countries have made major progress in financial cooperation.  The two sides will strengthen cooperation in renminbi (RMB) currency trading and clearing in the U.S.  China agreed to extend a 250 billion RMB Qualified Foreign Institutional Investor (RQFII) quota to the U.S., and designate one qualified bank from China and another from the U.S. as RMB clearing banks.  Both sides welcome the ongoing cooperation among trading platforms, so as to enhance connection of their financial markets and products.”

More can be read about this conference and the alignment between the US and China in the post Newstainment and Diametric Complexity – A Gap Analysis on South China Sea Tension and Global Governance Alignment.

These statements provide valuable insight on the relationship and coordination between the United States and China surrounding the evolution of the international monetary system.  Such evolution will attempt to correct global imbalances by appreciating the renminbi and depreciating the US dollar.

This correction, or adjustment, will shift wealth around the world with profound and substantial changes to how economies function.  The investment of 250 billion RMB by an American bank is a huge event which will be marked by a further decrease in US Treasuries.

This has long been predicted here on POM as the inevitable requirement for re-balancing of the monetary framework.  The recent announcement by the Federal Reserve not to raise interest rates aligns with Chinese demands for the same.  The intent is to create demand for domestic RMB bonds by decreasing demand for US Treasuries.

Eventually the Fed will have to begin raising interest rates and strengthen the domestic financial system within the US.  This will include the depreciation of the dollar which will facilitate an increase in exports. The coordination between the Fed and China on this aspect of the multilateral monetary transition is beginning to come into focus.

The challenge of depreciating the dollar while raising interest rates has always been fraught with difficulty.  It could be a situation where RMB demand will increase while Treasury sell-offs continue.  The dollar will experience depreciation as this demand wanes and once a pre-determined valuation has been reached the Fed will increase rates as the backstop to further unwanted depreciation.

What is clear is the coordination between the US and China is moving the world closer to a multilateral monetary framework.

This framework will gain additional momentum in the fall as the new SDR basket composition, which includes the renminbi, comes into effect.  This will be supported by a broader use of the SDR and the issuance of SDR bonds by China.

The G20 Hangzhou Summit in September will mark the major transition point this year. From that meeting large macro mandates will be established and new monetary policies will emerge.  The coordination between both of the large economic players in the world will work towards the goal of increasing global growth and reducing volatility.

Previous analysis presented here anticipated a depreciation of gold throughout this process.  We have seen gold make substantial gains in the first part of 2016, but I do not expect this to last.  This period of volatility, or uncertainty, will shift into the period of renminbi excitement and opportunity.  The growing investor confidence in the RMB bond markets, and the developing SDR bond markets, will support further Treasury diversification without the uncertainty which has caused the recent rise in gold.

The trend and path forward are well defined, but there will always be variations and adjustments along the way.  Timing these variations and adjustments for quick gain might not be the best approach.  The investment strategy which has been discussed here on POM has always been one of long-term patience for sustainable gain.  – JC