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Marcuard's Market update by GaveKal Dragonomics
When Michael Milken invented junk bonds in the early 1980s, few foresaw that his new market would change the way companies financed themselves. Nor did they think it would alter how businesses looked at their cost of capital, trigger an M&A boom, midwife the birth of the private equity industry or change the way banks were run. However, with hindsight, it is obvious that the creation of junk bonds was one of the most important financial developments of the last 30 years. Yet the majority of investors remained oblivious of the shift for a very long time.
Fast forward 35 years and the question is whether investors are once again in danger of ‘missing the forest for the trees’. The single most important financial development of recent years might well be the creation of the Dim Sum bond market. Yet few investors seem to care. Today, the world’s second largest economy and its largest exporter is creating a new bond market whose stated purpose is to provide an alternative source of financing for emerging market companies, and to help China break its US dollar dependency and move towards financing trade in its own currency. Things are moving fast: in just four years, China has gone from settling none of its trade in renminbi to settling a quarter.
For China to succeed in shifting its trade away from US dollars and into renminbi, it needs three things: a) a stable bond market (so people can park excess renminbi in yield-generating investments), b) a credible capital market (China is lucky as the only emerging market with a credible financial centre—Hong Kong), and c) a strong currency (who wants to save, or keep working capital, in Indonesian rupiah or Turkish lira?).
Which brings us to the recent strength of the renminbi. While the weakness of the euro, yen, pound, and Swiss franc against the US dollar have captured investors’ attention lately, few have noticed that the Chinese currency has in turn outperformed the US dollar, making all time highs against the yen, and is not far off of its record high against the euro.
One can point to many factors behind this strength, but the bottom line is that Beijing wants to establish the renminbi as the trading currency for emerging markets, and will only succeed if the renminbi is strong. At a time when most major central banks are keen only to debase their currencies, it is notable that one central bank has chosen a non-quantitative easing, non-zero interest rate policy approach. As we see it, China’s intention to internationalise its currency means that the renminbi and renminbi bonds remain among the best risk-adjusted stores of value available to investors today.
