Two recent news stories have caught my eye and I thought they were worth sharing. Neither story is earth-shattering, but each is significant in its own way. The first one adds another piece to the puzzle relating to the longevity of the U.S. dollar as the world’s reserve currency. The second story is one that makes you think about some of the creative ways the developed world debt crisis might be solved. The first story, reported by Bloomberg on December 29, 2011, discusses a recent agreement between Japan and China to reduce the role of the U.S. dollar in their trading relations. Below is an excerpt of the Bloomberg article:
The agreement announced between China and Japan to strengthen financial ties and promote yuan-yen trade is a small, but notable, step toward a new global economy. Its immediate practical significance is limited, yet the deal signals that a deeper transformation is under way — and one that the world should welcome. The plan was a surprise: It marks a warming of relations that had been chilly of late. The accord still lacks a timetable for implementation, but once in force it will let Chinese and Japanese trading companies switch between yuan and yen without converting to dollars first. This will encourage commerce by reducing currency risk and trading costs. The agreement will let a Japanese-backed institution sell yuan bonds in China, helping to open China’s capital market. In return, Japan will convert some of its foreign- exchange reserves into Chinese bonds. China has signed financial pacts with other nations, mainly in Asia, but the size of China-Japan trade — $340 billion last year, and growing fast — makes this deal the most important by far. Warmer relations and short-term benefits for regional trade, though, are not the main reasons the agreement matters. China seeks a bigger role for its currency in global markets, and wants power in international forums that is commensurate with its economic might. The sooner its currency is fully convertible and its economy is open to global investment, the sooner this will happen.
Given China’s significant role in the world both as an exporter and an importer, it makes a lot of sense for their currency to become one of the major currencies used in trade and to be used ultimately as a currency to diversify reserves. China has been careful to control its currency up to this point. This has provided them with an advantage as their economy has been developing in recent decades, but the time is not far off when it will actually benefit them to open up their currency to the world.
The second news item comes out of Europe and has to do with debt—but it’s not what you think. On January 9, 2012, Germany sold six-month treasury bills at a negative yield for the first time in history. According to this Bloomberg article:
The government auctioned 3.9 billion euros ($4.98 billion) of securities maturing in July at an average yield of minus 0.01 percent, the Federal Finance Agency said in an e-mailed statement today. It was the first time it sold the securities at a negative yield, Joerg Mueller, a spokesman in Frankfurt, said in a telephone interview. The sale drew bids that were nearly double the amount allotted. The Netherlands sold securities due in March at a yield of zero on Jan. 3.
Investors are actually willing to pay the German government in order to guarantee their principal will be returned in six months! They’ll make $500,000 on this issue. If Germany is being paid to issue debt, maybe they can issue enough debt to make enough money to pay off some of the debts of its neighbors. Joking aside, this may signal one of a couple things: (1) there is not enough high grade debt out there to meet the normal demand; or (2) investors are quite pessimistic about the future and therefore demanding more safe-haven assets. Either way, for a long-term investor who believes the developed world will recover from its current debt challenges, it offers a more compelling case to consider equities with P/E multiples at multi-decade lows and yields on European equities near 4%.
