Has China Got The Right Model?

China has been working for several years now to become a real player in world markets and to see its currency, the renminbi, achieve a place amongst the strongest, most used currencies in the world.

It has gone through the International Monetary Fund seeking the ability to be used as a reserve currency. And, it has been learning by doing in terms of its currency functioning within the world currency markets.

Well, the second-quarter data indicates that China may really be succeeding in its efforts to “play the game” in global markets.

Gabriel Wildau writes in the Financial Times:

The renminbi has strengthened 3.4 percent this year (against the US dollar), reversing its record 6.5 percent fall last year, in part reflecting efforts to squeeze bearish speculator and boost confidence.”

“Meanwhile, forex reserves rose for a sixth straight month in July, according to separate data. This marks the longest run of increases since 2014, when reserves touched a record $3.99 trillion. Forex reserves were up $24 billion from a month earlier and $80 billion from January’s five-year low.”

One might remember all the problems the Chinese were having in world financial markets in the late summer and fall of 2016, although much of the noise at that time came from the fact that in June of that year, Great Britain voted to leave the European Union and that tended to dominate the Western press corps.

Chinese officials seemed to be scrambling all over the place to steady things in the foreign exchange market at that time and they were very active in attempting to control international flows of funds.

Now, things appear calm and the Chinese officials seem to be on top of things.

China wants a strong, stable currency. It sees this as crucial to its future place in the global economy. And, as we have seen since Davos in January, the Chinese are now taking the lead in promoting and supporting globalization.

And, if a country is going to lead in the effort to build up the global economy, that country must have a strong currency.

So, it appears as if the Chinese leaders consider the strength of the yuan in almost everything it does. Any policy that will impact world trade and world capital flows must now consider what is going to happen to the renminbi.

And, bottom line, this is what China believes it has to do to challenge the global leadership of the United States.

The United States had a monopoly on the strongest currency in the world. This was in the 1940s and 1950s. The US dollar is still the strongest currency in the world, but…

In the early 1960s, the United States started down the road to financialization and credit inflation. By the end of the 1960s, the dollar was in trouble at its fixed price.

Finally, on August 15, 1971, President Nixon freed the dollar and the price of the dollar was allowed to float in world foreign exchange markets. With two exceptions, the secular trend of US government policy was one of credit inflation and a weakening of the dollar.

By the beginning of the recent financial crisis, the value of the dollar was down by more than one-third of the value it traded at soon after the currency was floated.

There have been times in the last couple of years when it appeared as if leaders in the United States were going to pick up on the strong dollar and commit to attaining and maintaining a strong dollar as US policy.

Well, it looks as if that time is past. President Trump is all for a “weaker” dollar. And, the Federal Reserve does not seem to see a strong dollar over the near term. And, basically since early May, players in the foreign exchange markets have come to the conclusion that the United States is not going to come through and support a strong dollar. In fact, it seems as if the bet on the future of US governmental policy is going to be for more and more credit inflation, and this has been reflected in the US stock market, and for a weaker dollar.

At the end of last week, for example, the foreign exchange market toyed around with a $1.1900 dollar price for one euro, whereas in early May it took about $1.09 to buy a euro. The value of the dollar also declined against the renminbi since that time.

Although the Chinese are not yet “home” in terms of achieving the stability they want in their currency, they definitely are “on the track” to achieve this over the longer run.

So, while the United States backs off of world trade and has a presidential administration that vocally advocates for a weaker dollar, the Chinese move to become the main proponent in the world for globalized trade and to also become a leader in terms of the strength of its currency.

This seems to be the model the Chinese are working from. Is it the right model?

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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