So this is my follow up to my BloombergViews on RMB deinternationalization. One issue that I wanted to address specifically is that I had a couple of people question whether this was more of a short term blip rather than a structural issue. As usual start there and come here for additional analysis and discussion.
- The RMB is deinternationalizing for a very straight forward reason: if the RMB continues to internationalize, Beijing will lose control of the price and flows. Full stop. Unfortunately, there are no other reasons. Fortunately, this makes very clear predictions and mathematical relationships about when it will happen.
- Let’s look at the price. The more RMB that is outside of China the more market participants will trade RMB at whatever price they want to trade it and not at the price Beijing wants. In fact, a major driver of the reduction in offshore RMB, primarily in Hong Kong, is the continual intervention by the PBOC is propping up the RMB. To hold the value of the offshore RMB (the CNH as it is known) the PBOC buys RMB in Hong Kong selling USD. If the RMB really internationalized, Beijing would have to manage RMB prices around the world an actively intervene even more than it does. Beijing is clearly not willing to give the market any real type of influence in setting the price. How do we know this? If you look at the CNY/CNH spread the CNH is virtually always trading at a not insignificant discount to the CNY, with clear regular intervention. If the CNY was truly following market indicators, with any real interest, the CNY would be significantly lower than it is today. In short, internationalizing the RMB means Beijing giving pricing control over the RMB much more significantly to the market. The RMB is deinternationalizing because Beijing is exerting greater control over the price.
- Then there is the flow of RMB. If the RMB is to internationalize, the Beijing will have to enormously relax its grip on the flows of RMB. I know people have cited a couple of examples but if you will notice these are examples that let foreigners invest in Beijing is more than happy to let money flow in one direction: in. However, all recent measures about outflows are tightening. Before you even start with talk about M&A and FDI, May capital payments (i.e. outflows were only up 1% from May 2015 and are only up about 10% for the year. If the RMB internationalizes, Beijing must lose its control over RMB flows. This is not some speculative musing this is empirical reality. If RMB is to be widely used either around the world or even for transactions involving China people have to be free to use the currency when, where, and how they choose. If RMB is to be used around the world and challenge the dollar or even the Danish Krone, RMB must flow out into the rest of the world.
- Now the price and the flow issues combine to tell us very real information. If RMB needs to flow into the rest of the world to become an international currency, this means there will be downward pressure on the RMB. If Beijing relaxes its grip on the directionality allowing the RMB to internationalize, this will place long term downward pressure on the RMB reducing its value. There is another way to think of this: if Beijing wants to hold the value of the RMB higher, it will continue to deinternationalize the RMB. If Beijing is willing to let the RMB depreciate, the RMB will internationalize. The only way the RMB can internationalize and rise in value is if the demand for RMB assets significantly outstrips demand for foreign assets. There are two reasons this is unlikely. There is an asymmetric relationship in that foreign investors are much more able to hold RMB assets than Chinese holding foreign assets. In other words, there is a lot of pent up demand by RMB holders for non-RMB assets. Furthermore, given the law of large numbers, China would have to absorb such a vast amount of world savings and investment in the future to push the RMB higher on a strictly flow basis to render this all but impossible. In other words, this gives us the pre-conditions under which the RMB will internationalize and what we will see both with flows and with RMB.
- For all the talk of RMB internationalization, please explain to me how a currency can be “international” when it isn’t allowed to leave the country and is engaged in such a small number of international transactions? Are you aware that almost 80% of all “international” RMB transactions are with China and Hong Kong? Seriously stop and think about that for one minute. Almost 80% of “international” RMB transactions made between China-China or China-Hong Kong. Put another way, 80% of international RMB transactions are made with domestic counterparties. The RMB internationalization talk is the equivalent of playing Xbox World Cup in your Mom’s basement and claiming you are a world class athlete.
- There is a very clear markers around which we will be able to tell the RMB has internationalized and not the fake IMF version. So far, the RMB is not even close and is clearly going in reverse.