In the context of the global currency war, Australia’s central bank doesn’t pack a lot of firepower. In fact, the Reserve Bank of Australia’s balance sheet is downright puny compared to the trillions sloshing around global capital markets.
It’s the big boys who determine the currency cross rates.
But our take this week is that the RBA’s decision to allocate 5% of its $38 billion foreign currency reserves to Chinese sovereign bonds (CNY) is still a telling move. It could prove the continuation of a major trend away from the USD and toward the long term rise of the Chinese yuan…
The Currency to Watch Over the Next Decade
In case you missed it, here’s a snippet of the story from CNN on Wednesday:
‘This decision to invest in China is an important one. It reflects the broader economic relationship between China and Australia and our increasing financial ties’, Philip Lowe, deputy governor of the Reserve Bank of Australia, said in a speech on Wednesday in Shanghai. “It provides greater diversification of our investments and will help with our understanding of the Chinese financial markets.
‘Earlier this month, Australia became only the third country to establish a direct currency trading link with China, after the US and Japan. The RBA and the People’s Bank of China also set up a currency swap facility in March 2012. The RBA had around A$38.2bn ($39bn) in foreign reserves at the end of March.’
The only other country in Asia that Australia directly invests in the government bond market is Japan. So watching the Chinese yuan is going to be fascinating over the next decade.
If China liberalises its currency, it will cause a profound shift in financial markets. It could even push the focus of global currency trading from London and New York further east to Shanghai and Hong Kong.
The first key date to watch is in 2015 when the IMF looks to rebalance the currency weightings that underpin its Special Drawing Rights (SDR’S). Of course, it won’t just be the yuan to keep your eye on. You could also get a shift in the balance of power in the IMF from the G-8 to the BRICS. That could mean the Brazilian real, Russian ruble and Indian rupee gaining more importance in world currency markets.
So Australia has been invited to join the party. And where Australia goes, eventually others will surely follow. You’d think over time more and more central banks will look/be invited to add CNY assets to their reserves as the Middle Kingdom opens up. This could go along with gold nicely to spread their bets away from the current top two central bank reserve holdings, the euro and the US dollar.
In the meantime, though, the yuan is hard to get at because of China’s closed capital account. That means China proxies like the Australian dollar attract flows of money.
That goes some way to explaining the divergence between the CRB commodities index and the Aussie dollar since the beginning of last year. This is something Slipstream Trader Murray Dawes pointed out on Thursday.
Murray made the case that, in the short term, he sees more risk to the downside for the Aussie than upside potential against the USD. He says the Aussie is in an intermediate downtrend.
Time will tell. At the very least, you should start thinking about insuring your wealth against the possibility that the Australian dollar falls…
Consider Global Blue Chip Stocks
The Australian stock market isn’t very diversified compared to other major stock markets. For example, the big four banks make up (at the time of writing), 29% of the ASX/200. That’s an enormous percentage. It means buying the index gives you a very large exposure to one industry. That’s not great. The whole point of buying an index is to diversify your holdings over different industries with different business cycles.
So one idea is to take a look at global blue chips. This gives you a chance to buy large companies that operate in different countries. This should make them less susceptible to one economy or industry running into trouble. Big companies will have the cash flow to withstand the current volatility in the financial system.
Australia doesn’t have a lot of companies with global reach. But don’t let that put you off. Consider that, amongst other things, foreign shares can give you exposure to industries where Australian businesses don’t have a major presence.
Technology is a great example. Most of the innovation here still comes out of the USA. This is something our new technology analyst Sam Volkering will be covering for you in much more detail soon.
In the long term, as long as the RBA continues to sit on the sidelines in the currency war, we think the case for a relatively strong Australian dollar holds. But it can’t hurt to consider using it to get exposure to overseas markets while it stays that way.
Callum Newman
Editor, Money Weekend
PS. Don’t forget if you want to keep track of the latest things we’re reading and brief commentary on events that happen through the day, check out our Google+ page and Kris Sayce’s as well.
From the Port Phillip Publishing Library
Special Report: TORRENT SIGNAL 3
Daily Reckoning: Praying for Government Incompetence
Money Morning: The Market Rebounds, but We’re Still Not Selling…
Pursuit of Happiness: 3-D Printing: Solving One of our Biggest Economic Issues
