How China Is About to Flip from Trade Exports to Trade Services
By JC Collins
The Made In China label became a symbol of economic production lost in the western world alongside the rise of cheap labor and goods from the emerging economies. The cultural meme of "everything made in China" became common and could be heard at any given moment, anywhere in the developed world.
Whole industries and business models were built around the economic methodology of exporting cheap goods. Such as numerous chains of dollar stores, and brand name clothing outlets, which manufactured products in the Chinese provinces with the lowest labor costs, and then sold the goods at inflated prices to the developed world.
China now has the largest economy on Earth, and the monetary structure which made the USD the center of the solar system is shifting towards a multilateral framework. The Chinese currency, renminbi (RMB), or otherwise yuan, which is the unit of measurement, (such as the relationship between the British sterling and its unit of measurement the pound), will soon no longer be taking a subservient position against the American dollar.
The yuan, in both its on-shore and off-shore variations, has also been called the redback, drawing on the nickname of the USD, and it's civil war version, the greenback. For years the redback has maintained a managed currency peg with the USD. This exchange rate regime has been managed by the Chinese government and the People's Bank of China at an undervalued false exchange rate.
Over the last 5 years the redback has become more widely used for global payments, financial investments, and reserve management. The large amount of Bilateral Swap Agreements, BSA's, and broader acceptance, has not yet been priced into the valuation. Nor has the growing status of the Chinese economy itself. Read more in the post Renminbi Is Already A De Facto Reserve Currency.
One of the main reasons for the internationalization of the RMB is directly related to the multilateral supra-sovereign reserve asset called the Special Drawing Right. The SDR is the unit of account used by the International Monetary Fund and is being re-worked as the global reserve unit of account which will replace the USD in the coming months and years.
The SDR basket is currently based on the valuations of the USD, the yen, pound, and euro. Every 5 years the basket is adjusted and currencies are included or removed. This the year the basket will again be adjusted and the redback will be added.
There are a number of reasons supporting this measure, but none more so than the need for stability in global liquidity. The growing sovereign debt crisis which is spreading from country to country will require large scale debt restructuring on a level that no one economy or domestic currency can handle effectively and efficiently.
The optimization of sovereign debt restructuring will take place through multiple methods, such as the SDRM process of the IMF, or Sovereign Debt Restructuring Mechanism. Other methods will be CAC's, or Collective Actions Clauses. The CAC process will be initially, and primarily, used as a method of incorporating into the issuance of RMB bonds - which will be used in a broader array of debt instruments and bank loans - the methods to address the sovereign debt issue. This process will be used in Greece and the Eurozone as the multilateral develops further into its broader global framework. See post BRICS SDR to Bailout Eurozone.
The RMB CAC and BSA dual machinations will build upward towards the SDRM and the utilization of SDR denominated bonds to address global liquidity concerns. These bonds will be issued through the BRICS Development Bank and other financial institutions as the process is expanded internationally.
The inclusion of the redback in the SDR basket is required to bring broader stability to the SDR before the debt restructuring can begin in both CAC and SDRM methods. This stability can only be realized if the RMB ends its managed peg to the USD and is allowed to free float on the forex markets.
The yuan is significantly undervalued and needs to be strengthened before its inclusion into the SDR basket. The initial IMF meeting to discuss the SDR is in May of this year, with the actual adjustments taking place in the fall months. This means that sometime in the next few months Chinese authorities will have to end the managed peg and allow the redback to become more market oriented.
There is a concern amongst economic analysts that China is headed for a "soft landing' or a "hard landing" as it's credit markets contract and economic growth slows alongside the global deflation which is worming its way through the sinuses of the existing international system. This line of thought continues into the managed float regime as conclusions are made and published that China will not allow the redback to float freely on the forex markets because it could lead to a devaluation.
This simply will not happen because the actual real world value of the RMB has not been priced into the managed regime. Once the managed peg is ended and the currency free floats, the yuan will experience strong real exchange rate appreciation as the existing BSA's and foreign reserve amounts increase dramatically alongside the further internationalization and inclusion into the SDR basket.
The argument which is made against the appreciation of the yuan is that it would destroy China's trade exporting economy. As such, it would further reduce economic growth and deepen the contraction of credit markets in the country.
What isn't widely accepted is that the appreciation of the RMB and a move away from the existing trade exporting model is exactly what China wants. Not only do they want it to happen, but they have taken strategic and necessary steps to ensure that it happens.
Over the last 10 to 15 years China has continued to modernize along with the flow of economic growth. At one point, China was building the equivalent of three Chicago's every year. The construction of these ghost cities, which have remained relatively empty, created a world wide shortage of iron and rubber.
Many analysts assume that since these cities have sat empty all this time that it was a clear sign of a real estate bubble in China. But nothing could be further from the truth.
The engineering of the ghost cities were a part of the National New Urbanization Plan which intends to move 100 million people from the rural population into the cities by 2020. The intent is to increase the urban population of China by 60% and create a larger consumer class as the economy shifts away from the exporting model.
This will be the largest human migration in the history of the world. The economic strategies and cultural engineering used to accomplish it will be studied for generations to come.
China is about to create a middle class.
In its efforts to regain the superpower status which it had previously held three times in the last 2000 years - the Han Dynasty, the Tang Dynasty, and the Qing Dynasty - China has developed an urbanization plan which is meant to attract "elite human talent" to the "elite cities" which will be structured under strict population controls and citizenship will be based on a point system.
As the old world USD based system recedes into the shadows of yesterday, (like the British Empire before it) we can determine that the National New Urbanization Plan of China will become, under the emerging multilateral framework, the Global Urbanization Plan of the United Nations. See post Development Goals of the New World Order and The Globalization of Central Banks.
For all the GDP growth and opportunity to modernize which the exporting model afforded China, it came with some increasingly apparent downfalls. First, the trade exporting model creates massive inequality within the population, which is being addressed by increasing the percentage of urban population and decreasing the percentage of rural population.
Secondly, it contributed directly and indirectly to under-consumption and over-investment. This will be reversed by shifting the Chinese economy from the existing trade exporting model to a trade services model.
The exporting model is self-explanatory but the trade services model may need some further review.
As the redback appreciates and is added to the SDR as one of the reserve currencies making up the basket, China will be looking at ways of expanding existing services and creating new ones. These services consist of financial services (think Eurozone bailout and McDonald's bonds), communications, transportation into international markets and regions, promoting tourism, and the exporting of media and traditional Chinese values and heritage.
Chinese economic strategists have a set a target of reaching $1 trillion of Trade Services by 2020, the same year in which the urbanization plan is set to include 60% of the population. This is a dramatic shift away from the policy of exporting goods which carried the growth of the Chinese economy for decades.
When China ends the managed peg to the USD, other ASEAN economies will follow. As a broadening of the Chiang Mai Initiative Multilateralization, member countries such as Vietnam, Malaysia, and Indonesia, amongst others, will also end existing pegs and establish floating pegs with the RMB. The strong economies amongst the group will see currency appreciations alongside the redback. See posts Why the Vietnamese Dong Will Reset, The Dongs Revaluation is Imminent, and Dong & the Pan-Asian FX Trading Center.
The geopolitical tension which is taking place in the world is symptomatic of this transition away from the unipolar USD based system towards the framework and macroprudential policies of the multilateral SDR based system.
The USD, which has held the position of the Sun in the solar system since 1944, will soon be relegated to the position of a Jovian Giant, alongside the redback, as the SDR moves into the center position, from which all other currencies and commodities will both define, and maintain, their orbits.
The greenback, like the redback, are both about to go through some dramatic adjustments and re-engineering as the multilateral continues to emerge. - JC