Largely lost beneath the noise of the S&P downgrade and the legitimate discrepancy allowing France to maintain their AAA rating was the Peoples’ Bank of China’s actions creating new financial channels for opening up their currency and banking markets to the global economy. China is increasing the pace at which it seeks to become a globally dominant economy as it restructures the archaic financial systems that are the foundation of their stranglehold of restrictive trade and capital controls.
A basic background of their policies is necessary to understand the importance of their recent developments. The Chinese international money market is basically divided into two geographic locations with separate operating governances, rules and restrictions. The Peoples’ Bank of China controls the totality of all currency and lending practices as well as determining fiscal policies and international debt purchases. This group, headquartered in Beijing is the largest owner of U.S. debt with holdings of more than $1 TRILLION in U.S. Treasuries.
The primary hub of international currency trade and repatriation in the Yuan is Hong Kong. Hong Kong operates in a dysfunctional family sort of way. They are clearly under the supervision of main land China. However, they develop their own international trade relations, fiscal policies and domestic governance. Hong Kong is the eighth largest holder of U.S. debt with just under $120 billion in U.S. holdings.
These two units operate at such an arm’s length that there is a large gap in the exchange rate between Yuan held in Hong Kong versus Yuan held in China even though it is the same currency. China has been issuing certificates of deposit to Chinese citizens that earn a yield of 3.37% while Hong Kong’s offering to its citizens earns only 1.6%. China does not allow direct investment by foreign people, banks or, corporations while Hong Kong does. Therefore, the primary global access to Yuan currency appreciation has come through the Hong Kong financial markets. The demand for Chinese Yuan and its expected appreciation is what is driving Hong Kong yields below those of China’s.
The issue at hand is that main land China is easing its regulations on the Hong Kong banking markets to sell Yuan based debt to global institutions. The primary step in this process is opening the gates of Yuan flows from Hong Kong back to China. This will help even out the yields between the two countries, which in turn will allow Hong Kong’s financial markets to accept much greater inflows without tremendously fueling domestic inflation.
China just issued 20 billion Yuan in Treasury Bonds through the Hong Kong financial markets. This is the third time in three years with the previous years’ issuances at 8 and 6 billion Yuan, respectively. The increasing size of these auctions is a clear signal that China is re-balancing their currency portfolio and at the same time, generating inroads to the global Treasury markets. Main land China is still controlling the allocation of their issuance. The allocation was preset by country and type of investor to curb outright currency speculation.
The point is that this is a game changer in the international financial markets. The strongest economy in the world is adopting western exchange mechanisms. The more transparent their regulations become, the more competition there will be for debt issued in Yuan at a time when U.S. Treasuries and the European Central Bank become mired in the abyss of their own hubris. We are witnessing a paradigm shift in real time.
This blog is published by Andy
Waldock. Andy Waldock is a trader, analyst, broker and asset manager.
Therefore, Andy Waldock may have positions for himself, his family, or, his
clients in any market discussed. The blog is meant for educational purposes and
to develop a dialogue among those with an interest in the commodity markets.
The commodity markets employ a high degree of leverage and may not be suitable
for all investors. There is substantial risk of loss in investing in futures.
