The Year of The Redback

It has been unmistakably the year of the redback.

The euro is at a ten year low against the Chinese yuan with it currently trading at 7.5 to the euro. In just six months alone the yuan has appreciated 11.6 percent against the euro (at the time of writing this piece).

But this might be more than just an appreciating yuan story.

What we could be seeing is a change in priorities being adopted by the monetary authorities in China.

It wasn't so long ago that Chinese monetary authorities were deliberately adopting a policy to devalue the yuan with the aim of giving Chinese exports a heads up abroad, making Chinese goods more competitive in foreign markets.

The artificially low yuan was a such contemptuous issue that the economic heavyweights, China and the US, locked swords over it in the past, with the US arguing that the yuan should be allowed to float freely on the foreign-exchange market. By allowing the yuan to float the market would price in a higher exchange value of the currency. The US believed that the previous value of the yuan was being suppressed by central bank intervention. It was artificially too low causing trade imbalances and disadvantaging for US and foreign manufacturers. In the past, China had been criticised by US officials for flooding the US market with cheap tires and depressing the price of exports by manipulating its currency.

It was no secret that the Chinese government did previously dictate the value of the yuan against the U.S. Dollar through a strategy known as “pegging,” up until June 2010.

Since then, China’s claimed to have abandoned the pegging system and prior to the last six months the value of the yuan traded within a narrow range.

Despite the double digit phenomenal economic growth experienced by China during its peek boom period, the yuan surprisingly continued to trade within a narrow price range for years. This seemed odd in a climate of booming Chinese exports. If the strategy of pegging had been abolished and the yuan was free floating, higher exports would also have meant more demand for the yuan, which ought to have appreciated its price in the foreign exchange market. But that just didn't materialise and it was only until the last six months that the yuan started heading upwards.

Why the relatively sudden appreciation in the yuan?

It is now obvious that the Chinese monetary authorities are no longer solely focused on manipulating the price of the yuan to boost Chinese exports.

But it would be naive to believe that their move to allow the yuan to appreciate is being carried out to appease the US and do as they’re told.

Bearing in mind that the China makes no bones by saying publicly what they think about the US economy. Remember, in February 2014 China stood up to the US and said the “US economy is fake, the dollar is backed by nothing and the US has no manufacturing to support it.”

So could the recent depreciation in the yuan be part of a Chinese monetary authority's agenda to elevate the yuan to reserve currency status of the world?

For a currency to be widely accepted and used as a world's reserve it would need to be a good store of value. If the yuan holds its value, or even better appreciates, then it would elevate international investor’s confidence in the currency as a potential reserve currency.

The rapid rise in importance of the yuan in international transactions cannot be overstated. For example, take China’s launch of its “Shanghai-Hong Kong Stock Connect” program back in November, which enabled for the first time ever, retail investors around the world to be able to invest in mainland Chinese equities. The program created the world’s second-largest equity market by market cap

Some even argued that this was the beginning of sea-change in a shift in global stock trade from West to East.

With transactions being conducted in yuan this was a major leg-up for the redback.

Then there was Shanghai launching its gold exchange back in September, which enabled foreign investors to participate in China's rapidly growing bullion trading market. The move not only boosted China's yellow metal pricing power, it also promoted the use of the Chinese currency globally.

In both instances, the Shanghai-Hong Kong Stock Connect and the Shanghai gold exchange have two things in common; they promote the use of the yuan globally with the US dollar increasingly being left out in the cold.

Not to mention China's shiny new Asian Infrastructure Investment Development Bank (AIIDB), which has deep enough pockets to compete with the International Monetary Fund (IMF) and the World Bank. Strapped cashed countries now have a choice of where to go when they are in need of finance. Previously, the IMF and the World Bank, with its political strings attached, had a monopoly over keeping heavily indebted countries afloat. Now there is the Asian Infrastructure Investment Development Bank offering credit with no doubt its own political strings.

More recently, December 29, China will start swaps and forwards between the yuan and the national currencies of Russia, Malaysia and New Zealand.

What we are seeing is the US dollar hegemony coming under fire with the redback on the assault. While the past decade has seen the largest industrialisation on the planet with China's economy growing at a double digit rate, over the next few years the story might be the rapid rise of importance that China plays in global finance. The redback is a serious contender to the greenback. It has the potential to knock the greenback off its thrown as the world's reserve currency.

But the US is unlikely to surrender its thrown without a fight.

Could 2015 be the year when central banks in China and the US battle it out with rate rises and currency manipulation? Will it be a contest for world dominance, to be the world's reserve currency? If so, emerging country’s currencies are likely to get caught-up in the cross fire.