Forget, for a moment, the uncertainties surrounding President-elect Donald Trump. Because in the East, the world’s biggest ever credit boom is set to get even bigger. What’s more, it is not being built around the US dollar, but around a new emerging global currency: the Chinese yuan.
Constrained in East Asia by a combination of geography and America’s still mighty military presence, China has turned its eyes westwards.
The “One Belt, One Road” programme, or OBOR, is an attempt to build a new Silk Road – to connect China with new trading partners via a vast programme of infrastructure investment along four economic land/sea corridors, the most prominent element of which is the route to European markets, via Central Asia.
The OBOR framework was announced two years ago by the general secretary of the Communist Party of China, Xi Jinping.
Part funded by international organisations such as the World Bank, the Asian Development Bank (ADB) and the new Asian Infrastructure Investment Bank (AIIB), it involves the creation of new high-speed rail links, highways, port facilities, airports and power plants in 65 countries embracing close to four billion people.
When it is complete, the OBOR project will have cost a massive $4 trillion – the equivalent of one quarter of the entire US economy, and over 30 times the size of the post-WWII Marshall Aid budget.
Such is its financial and geopolitical significance that it will likely be judged alongside Deng Xiaoping’s economic reforms and China’s entry into the World Trade Organisation in 2001 as a key stage in the country’s development.
Why is the OBOR, this financial Silk Road, so important?
For China to prosper, it needs to overcome four medium-term challenges: internationalising the yuan; reforming its SOEs (state-owned enterprises); securing access to resources, not least cleaner energy (since coal still represents 40 per cent of China’s primary energy usage); and maintaining existing trade relations with the US.
The OBOR programme will resolve many if not all of these issues, either by default or by design.
At least one third of the OBOR spending will likely be on infrastructure, adding over $50 billion each year to construction spending in Asia and providing adding an extra 0.5 per cent to Asian GDP growth.
Our estimates at Cross Border Capital suggest that up to one third of this infrastructure budget will be spent on roads and port facilities, 30 per cent on motorways and airports, and some 20 per cent on power generation.
The OBOR’s focus on infrastructure seeks to address the areas that an increasingly urbanised pan-Asian economy has failed to invest in – the large parts of Central Asia that have done little since the collapse of the Soviet regime.
This will begin with national projects (already some $230 billion are underway, including the domestic leg of the $46 billion China-Pakistan Economic Corridor) before turning towards transnational and pan-regional ones.
But OBOR isn’t just about GDP. It is also a means to an end.
After the fall of Constantinople to the Ottomans in 1453, trade along the old Silk Road was driven more by China’s lust for silver than the West’s demand for paper, silk, tea and spices. As a result, China’s monetary system became enslaved to the silver peso, with more circulating in China than in Mexico itself.
Now, China’s economy has become similarly hooked on the US dollar.
China’s GDP is now 60 times larger than it was before Deng’s reforms in the early 1980s. India’s economy, by contrast, is around 20 times larger and the USA’s barely eight. And if you use real PPP dollars, says the IMF, China has actually grown 104-fold, meaning it overtook the US economy in effective size back in 2014.
Alongside that, China’s credit markets are an eye-watering 70 times larger than they were at the end of 1989: they now contain over 170 trillion yuan ($25 trillion).
But this rise has been built on dollar foundations: until a couple of years ago, foreign exchange comprised more than 90 per cent of China’s monetary base.
China has now “officially” stated, via the Communist Party media, that its aim is to depose the US dollar as the centrepiece of the world financial system, replacing it by a multi-currency alternative – or, more likely, eventually the yuan.
To this end, the recent inclusion of the yuan in the IMF’s Special Drawing Rights (SDR) currency unit is a significant first step. It remains largely symbolic, however, because the SDR is not used to settle real transactions.
Global economic power ultimately depends upon capital export and seigniorage, i.e. the ability to use your own national paper money and domestically denominated debt to purchase international assets and accumulate foreign capital cheaply.
And it turns out that the Chinese capital for the OBOR will largely take the form of official and quasi-official loans and development aid, denominated in yuan and effectively printed by the People’s Bank of China.
That money will circulate in the recipient economies and be held by local central banks as a settlement currency. Also, more and more Chinese exports will be priced in yuan, thus eliminating forex risks.
To put it another way, China’s geopolitical ambitions require that the yuan circulates internationally, is trusted as a standard of value, and can be used both as a payment currency for trade and an investment currency in financial markets. And the OBOR will help facilitate those goals.
History teaches us, from the Roman denarius to the British pound to the modern US dollar, that this transition of monetary power takes time. But, somewhere out in the future, the princeling yuan sits waiting to be crowned.
