Can Europe + China = 1 full cup of milk?
I just returned from yet another gathering of Europeans and Chinese to talk about their joint future. It’s great to see (or not see) that the Americans are excluded from the event. Typically, the Germans and French dominate but the Brits are usually observers. To be fair the Brits stage their own exclusive events with the Chinese. Good thing about Singaporeans – we are welcome to all events.
Anywayz, enough of introduction. The agenda of the gathering was to debate the evolution of the world currency market into a multi-currency one from the current one that is dominated by the USD. Specifically, they envision a world dominated by the USD + 4 (EUR, GBP, JPY, CNY). There was a call for a show of hands after the symposium and over half believe this would be the scenario in under 5 years from now. I couldn’t put up my hand because I think the world is more likely to end up with just USD and CNY. Let me elaborate. But first, I’m bounded by the Cheltham House Rules. So I won’t say which event this was, where I went and who I met.
– The EUR’s roughly 25% share of world reserves really came from combining their members’ reserves which were all converted into EUR after they jointly the EUR as their anchor currencies. The non-member reserves probably accounted for 5-10%. The USD’s share of world reserves still stand close to 60% and has in fact gone up in the past year. As a case in point – the Asian holdings of US Treasuries in proportion to their foreign reserves have also gone up rather than down in the past two years after recovering their reserves from the plunge during the Lehman-induced currency crash in 2008-09.
– So in reality, the EUR is really no where here without their members. The German leaders’ admission that they have benefitted the most from the monetary union all these years is meant for the ears of their electorates who would be voting for their Bundestag (parliament) sometime this September to October. Italy will run a presidential election on 24-25 February – the technocratic Monti government might just not make it because Mario Monti’s austerity measures have made him so hugely unpopular that the clever Silvio Berlusconi is now waiting in the wings to make a comeback. Bottom line is Italians are very different from Germans.
– So can the EUR really survive? The Germans are still insisting it will and in fact, they will go from monetary union (the formation of the EUR) to a fiscal union, a banking union and then a political union. At this point, I nearly wanted to put up my hand to say – wouldn’t it have been much more logical to do it the other way around – start with a political union, then a banking union, a fiscal union and a monetary union. I then recalled how I was hammered to the ground by another European leader about the same time a year ago in a similar Euro-Sino event. I asked then if the EU had a backup plan for member exit.
– Now over to China. There was a subtle message here from the Europeans to the Chinese – open up, float the RMB and together we can achieve a more balanced, i.e. a less USD-denominated world. But are the Chinese ready? The answer is “no”. But the reason isn’t as what everyone – including myself in the past – thinks. It’s not only that China’s domestic capital markets are shallow and its monetary policy still lacks a proper interest rate anchor. The reason is the US is not ready. It does China no good now to let the CNY float or turn fully convertible when the dollar and the US economy are still on a weak footing. Why let the RMB overshoot and invite problems of domestic overheating and jeopardize the export sector? This is not matrydom. It’s stupidity. China should float only when the US is stable. And it really doesn’t matter whether the Europeans are ready at that point.
– When do we know the US is ready? When we see the USD stops playng the contrarian risk barometer. We have seen many brief attempts last year during the near meltdown of the EUR. But the true turnaround is when the Fed signals it is ready to end QE.
The crux of the matter is this – the European economies have been in the “glass is half” state for a long, long time. Depending on whether you are German or Greek, one would argue it’s half full and the other would say it’s half empty. Can China help them to fill up the cup of milk? No.