4 November 2015

Currency Markets: The Next Battleground?

Last month we wrote a few articles on interest rates and the impact Central Bank policies will have on the currency and bond markets. The currency markets could be where the biggest volatility lies in the future. The reason is simply because the forex market is the biggest and most liquid market in the world.

Some recent developments by China suggest that major changes are coming to the currency markets sooner than people may think. According to an article in ZeroHedge, China dumped $94 billion in US treasuries during the month of August. (Source: ZeroHedge 2015 September 7th)

The article highlights that the sale of such a high amount of reserves was likely due to the Peoples Bank of China trying to maintain the stability of the Chinese Yuan after the currency was devalued over the summer.

This is a huge amount of foreign exchange reserves to liquidate in such a short time. With the global economy slowing down, Central Banks are going to have make adjustments to the composition of their currency reserves. 

The ZeroHedge article reported that Emerging Market currency reserves stand at about $7 trillion. So the bigger question is what happens if other countries begin to follow China’s lead and begin liquidating reserves?

The US Dollar would be at the forefront of this crisis because it is a reserve currency. With nothing tangible backing any currency, it is setting up what could become a highly unstable period for many currencies around the world. 

The IMF and the Yuan 

Another reason to suggest more volatility is coming to the currency markets is the addition of the Yuan to the IMF SDR currency basket. Regular readers know that in July the IMF was considering delaying entry of the Yuan into the SDR currency basket until September or October of next year.

However, according to an article by RT, the International Monetary Fund is about to include the Yuan into the its reserve basket of currencies. (Source: RT 2015 October 26th)

“Everything is on course technically and there is no obvious political obstacle. The report leans clearly towards including the RMB [yuan] in the basket but leaves the decision for the board,” an IMF official told Reuters, preferring not to be named. 

According to the article, The IMF will decide by November of this year whether to add the Yuan to the existing currency basket which includes the British Pound, the Euro, the Yen and the US Dollar. 

The story reports that France and the UK have backed the inclusion of the Yaun into the SDR currency basket. Germany and Italy are said to also be favorable towards the Yuan, so it looks like it will happen this month.

According to the Society for Worldwide Interbank Financial Telecommunication (SWIFT). As of August the Yuan has become the fourth most used currency in global payments with a 2.79% share, surpassing the Yen.

With China’s economy continuing to gain more influence in the coming years, the demand for the Yuan will only increase. This will ultimately cut into the foreign demand for the Euro and Dollar by other countries. This is more evidence that big changes are are coming to the currency markets.

China International Payment System (CIPS)

Back in September we did a two part article series on China and the East and how a subtle but major shift is happening in the global financial system.  As regular readers know, the Western based SWIFT has had a monopoly on the settlement of cross boarder payments for decades.

But now the game is changing. According to an article in RT, China’s Central Bank has announced a new global payment system which provides cross boarder transactions in Yuan. (Source: RT 2015 October 9th)

The new payment system, called China International Payment System (CIPS) is looking to internationalize the Chinese currency and challenge the dominance of the US Dollar. The Brussels SWIFT system is the largest financial settlement system in the world.

The article reports that so far 19 banks have been authorized to use the new payment system, including Citi, Deutsche Bank, HSBC and ANZ. 

The most likely outcome is that the CIPS system will not replace SWIFT but work along side the current system. But this is another major development that over time will have a huge impact on the currency markets. 

Although China is having its own economic challenges right now, over the long term it's influence and economic power will increase. This is another reason to expect battle to take place in the currency markets.

The Currency Markets and Gold

The volatility in the currency markets over the last year is likely only a warning sign of things to come. So far the major currencies of the world have held up relatively well, with the big volatility coming in the smaller and more obscure currencies.

With Gold in a deep bear market since 2011, many pundits have claimed that Gold has lost its safe haven status. Many have also said that because of financial engineering Gold no longer needs to play a role in the financial system.

But whats happening in the currency markets right would suggest otherwise. Gold, despite being down in US Dollars by some 40% over the last few years is doing it’s job when it comes to other currencies.

The Performance of Gold in Other Currencies

So lets take a look around the world and see what’s been happening with currencies and Gold. In the link to the video below, Mike Maloney looks at what Gold is doing in currencies outside of the US Dollar.

Link to Mike Maloney video

What is so interesting about this video is how Gold is near or at record highs in so many currencies. Gold is at record highs in the Columbian Peso, Brazilian Real, Syrian Pound, Iranian Rial, Argentine Peso and South African Rand.

Celtic Gold readers may not live in any of these countries, but it is interesting to note that all of these countries are having major problems with their economies. Thus, their currencies are collapsing. 

Currencies of developed economies like Canada and Australia have also not performed well. As a result, Gold is up in both of these currencies. The Gold price in Australian Dollars is about $1,560 and is up 15% over the last year. 

The Gold price in Canadian Dollars is about $1,465 and is up almost 10% over the past 12 months. These gains are despite Golds sharp decline this week.

The Gold price in Japanese Yen is flat for the year, however, over the last 5 years Gold has gained about 25% when priced in the Yen. It is interesting to note that Japan has arguably been the biggest abuser of quantitative easing over the last few years. As a result, Gold has been a good investment in Japanese Yen.

While Euro and Dollar owners of Gold have not seen much appreciation in the last few years, one can see from the data above that Gold is a key asset to own when your home currency comes under pressure.

The Global financial system is going to experience dramatic changes in the coming years. The currency markets will be one of the battlegrounds where these changes happen. This why owning Gold marked sense.

Author: celticgold.eu

Older The Playbook of the Central Banks is Becoming Clearer Newer CelticGold Market Report 9th November 2015