Jonathan Anderson resides as the Global emerging market economist at UBS. He has finally vanquished the false idea that China will out perform the United States as the market leader of a global world. This false idea of a supreme unchecked China rests on two promises that cannot be realized: the first is that the Chinese economy will soon be larger than the United States, the second is that the Yuan will replace the dollar as the world’s reserve currency. Both ideas are fatal mistakes of analysis and Dr. Anderson examines why this is so.
In order for the Chinese Yuan to outmaneuver the Dollar as the world’s reserve status, you must get the Yuan out of simple trade invoicing. If you hold the Yuan as a liquid ‘safe haven’ in your portfolio investment, then China must have free and deep domestic fixed income markets. Which it does not have and will not have so long as it remains Communist. You see, China maintains the most closed capital account regime in the world. This stands true even for developed market economies throughout Asia and emerging nations the world over. The biggest problem is that China cannot open its capital regime. For most of two decades China’s philosophy of monetary management and financial development has been based on a closed economic system: maintaining low and stable interest rates without having to worry about external arbitrage, constantly adopting economic stimulus when needed without concern about the banking systems asset quality, propping up banks with historically low or non performing loan ratio’s and fixed cost pricing. The Communist Chinese keep an iron clad hold over the exchange rate. All of these work when you have a political regime that forbids a true market from emerging. How else to say it: when the locals have no access to other markets, domestic or international, then funds cannot influence or set asset prices. This is how the current Chinese fiscal financial regime works. Even though China’s market is growing, its political control on capital remains the same. China has opened a few windows but left the doors firmly shut.
Even if China were to remove its external controls, it still does not have deep domestic markets. First, China needs to develop a local bond market.
China’s unique prevalence of undisciplined state owned borrowers with continued reliance on quantitative macro-credit measures makes it imperative to keep financial flows concentrated in a rigged banking system. This helps to explain why/how China’s bond market never grew when its GDP did.
The real hit for China will be when profligate Western sovereign borrowers stop printing money!
Making the Yuan into a true global reserve currency will not solve any of China’s current problems. China may be an economic giant on the world’s stage, but it will remain a financial midget.