As I apparently never tire of writing, the financial crisis that came to a head five years ago has resulted in an extended period of emergency ultra-low interest rates. The tried-and-true idea behind this is to give economic activity a boost by making loans carrying negative real interest rates readily available. “Free” money should make anyone with a pulse willing to borrow and spend.
In the past, these low-interest periods engineered by the Fed lasted at most a year. We’re now into year six of the current episode.
One result of this extremely long emergency period is that fixed income investors are currently lapping up low-coupon Italian, Greek…even Iraqi..sovereign debt. And crazy (in my view) fixed income products like contingent convertibles, no-covenant junk bonds and pik (payment in kind) junk bonds, where interest is paid in new bonds, not cash, are all finding eager buyers, as well.
Another is that savers living on interest payments (increasingly Baby Boomers), who are in effect subsidizing the financial rescue, are suffering. In fact, Millennials have just surpassed Boomers as the most important single demographic force in the US economy.
All of this is well-known.
Another development, though, which may turn out to be the most important in the long run, has escaped notice so far. It’s the increasing acceptance of the Chinese renminbi in world trade and in investment.
Fifteen, or even ten, years ago, China was content with the fact that all of its trade was effectively done in dollars. Beijing let Treasury bonds pile up in its coffers, to the point where it rivaled–and the surpassed–Japan as the largest creditor of the US. It had become uneasy about this situation even before the financial crisis. Stunned by the meltdown of 2008-09, China decided to offer its currency as a substitute for the dollar.
Until the past year or so, the renminbi has drawn pretty close to zero interest. This is partly because at first it wasn’t easy for either foreigners or Chinese parties to use the renminbi in trade. Also, foreigners can’t spend “offshore” renminbi in China itself.
Yes, the renminbi is easier to use today. But I think a big reason the renminbi is suddenly extremely popular now is the very low-interest rate environment we’re in. Multinationals with Chinese operations can save 3% – 5% by settling Chinese trade transactions in renminbi. In other circumstances, this might not be worth the hassle. But if your cash balances are earning effectively zero and if you have to buy a pik bond or Iraqi debt to get a 5%+ yield, then switching from dollar to renminbi trade settlement is a relative bonanza.
This movement seems to be feeding on itself. It’s causing very rapid growth in renminbi use, admittedly from a low base. I don’t think this development has any important immediate investment consequences. But it could end up making a profound (negative) impact on the dollar and the euro if it continues–as I expect it will. The ultimate result would be to make renminbi earners much more attractive as investments than they currently are.
The big investment question is when the inflection point will come, when the renminbi will begin to be regarded as a viable alternative to the dollar as the world’s reserve currency. Perception will likely precede reality by a long stretch …although I don’t think the tipping point will come this year or next. I view this as something important to keep in mind, however, so we can recognize what’s happening if this trend develops faster than I now think it will.