Steeling themselves

Why Chinese steel overcapacity will continue to test global steel producers’ patienceSince 2010, Chinese demand for steel has lagged far behind production and exports (Figure 1). In spite of this, production has remained strong with steel mills taking advantage of low iron ore prices at present. These sustained levels of production have been worrying producers of the metal around the globe as China ships its excess steel abroad. China is already the world’s largest steel manufacturer, in value terms they dwarf the whole of North America and are estimated to be responsible for around 50% of global overcapacity. Steel associations outside of China argue that China is flooding markets and hence driving steel prices down.  As a result of these concerns, eight representatives of steel organisations from around the globe (North America, Latin America and Europe) have lobbied China to alter its recent Steel Adjustment Policy 2015.




Figure 1  | Chinese Steel Exports and Imports, demand and production compared, based 2010
Source | DeltaMetrics 2015


Chinese iron and steel trade is highly correlated with the value of the yuan (and with equity markets across the region). Further, its trade generally is also highly correlated with the Iron and Steel price. Through a state-controlled steel industry, China is able artificially to drive down steel prices and effectively circumvent the market forces which all other global steel industries are susceptible to. The eight steel association representatives therefore hope China will rethink its steel policy for the benefit of the free market and the future of steel trade.

Delta Economics, sees encouraging signs of China reining in its steel exports in future. Between 2010 and 2015 (to the current month), we saw a compound average growth rate (CAGR) in Chinese steel exports of 10.7%. This was compared with 5.3% growth from North America, 1.3% in Latin America and 1.5% in Europe over the same period. However, between 2015 and 2020 we are now forecasting significantly lower CAGR growth in Chinese steel exports of 6.8%. This is compared with growth in steel exports in Latin America (4.2% to 2020), North America (6.2% to 2020) and Europe (2.6% to 2020). It appears, therefore, that China may well be listening to global concerns over its steel overcapacity.

This will not be a quick or easy process, however. It will take years of adjustments to address the Chinese steel surplus. Smaller steel mills within China are most likely to bear the brunt of the readjustment policy with plant closures and redundancies. However, the larger steel mills will be slower to change. Therefore, although our forecasts are showing more encouraging signs for steel producers outside of China, the coming years are likely to severely test the industry.



Nerves of steel  |  Author  |  Jack Harding  |  Analyst and Publications Manager

Growth, currencies and interest rates

Four trade challenges to monetary policy  |  Short summary:


The Fed needs to be careful about the next monetary steps it takes because:

  1. The growth effects of Quantitative Easing (QE) in Europe are yet to be felt, if indeed they will be
  2. Neither China nor Korea’s trade surplus with the US is the Fed’s biggest concern in emerging Asia
  3. The weak yen is not boosting Japan’s exports to the US and is not responsible for its surplus
  4. Monetary policy is not the answer to trade and growth imbalances, but has unintended consequences



In its bi-annual report to Congress, the US Department of the Treasury, International Affairs, assessed the macroeconomic policies of its major trading partners to see if inappropriate activities are being used to manipulate the balance of trade with the US. It urged the governments of Germany, China, South Korea and Japan to do everything in their power to eliminate global economic imbalances by focusing on reducing their trade surpluses with the US and halting practices of competitive devaluation against the US dollar. Against a backdrop of strong US growth and weaker growth elsewhere, the report argued that addressing these imbalances through structural reform, monetary and fiscal policy was the only way of ensuring that the G20 balanced global growth targets were met.


Four trade reasons why monetary policy alone can’t create real growth:


1  |  The growth effects of QE in Europe are yet to be felt, if indeed they will be

The immediate effect of QE has been to push European equity markets to new highs and push down the value of the euro against the USD. It is unlikely to create real, export-led growth since the correlation of the euro with Europe’s trade is positive (i.e. an increase in the value increases trade). Where it does have an effect on boosting trade, it is likely to be felt most strongly in Germany. This will potentially exacerbate the problem of its trade surplus, particularly with the US (Figure 1).



Figure 1  |  Monthly Value of German Exports to the US (USDm), June 2001 – December 2015 vs. EUR-USD, Last Price Monthly, June 2001 – March 2015
Source  |  DeltaMetrics 2015, Bloomberg


The chart shows a positive correlation (0.67): in other words, as the value of the euro increases, so too do exports. This reflects the relative exchange rate inelasticity of trade between Germany and the US. Growth in exports from Germany to the US has been modest over the past two years and the sharp reduction in the value of the euro does not appear to be likely to make much difference to its trade balance with the US.

The weaker euro is unlikely to impact Europe’s or, more specifically, Germany’s trade surplus with the US. Indeed, it is also unlikely to lead to greater demand without an accompanying non-monetary policy in Europe, such as infrastructural spending and structural reform to boost both demand and competitiveness.


2  |  Neither China nor South Korea’s trade surplus with the US is the Fed’s biggest concern in emerging Asia

The yuan is kept within a 2% peg of the US dollar and, as such, has been increasing its value since the end of 2004 when the currency was first allowed to float. More recently, March 2015, the yuan has appreciated against the US dollar giving rise to speculation that the peg is about to be loosened or removed completely (Figure 2).




Figure 2  |  Monthly Value of Chinese Exports to the US (USDbn) vs. USD-CNY Spot Price, Last Price Monthly, June 2001 – December 2015
Source  |  DeltaMetrics 2015, Bloomberg


The impact of the appreciation of the yuan is to suggest that Chinese exports to the US may flatten slightly during 2015. This provides some cause for optimism around the size of its trade surplus with the US. Of greater concern from a US perspective may be Russia’s decision to price oil and gas deals with China in yuan. This suggests that the yuan’s role as a trade finance currency is growing and that there will be further strengthening of the currency. This is likely to be a result of both a loosening of the peg and the role of the yuan as a trade finance currency. The threat of a stronger yuan and the prospect of a future currency war may be more unpalatable than the trade surplus now.

The won is slightly different in that it is only very weakly correlated with South Korea’s exports to the US at -0.46. In other words, any devaluation by the Korean monetary authorities is unlikely to have much, if any, impact on its trade surplus with the US. Given the speed that the Kospi has picked up since QE in Europe has prompted greater liquidity, the US would do well to look at the consequences of capital outflows and rising dollar-denominated debt as Asia’s slowdown works through. Priced in local currencies, such as the won, the markets look buoyant; priced in dollars, the rises are less substantial and represent both a loss in earning and pose a threat when dollar-denominated debt has to be repaid.


3  |  The weak yen is not boosting Japan’s exports to the US and is not responsible for its surplus

Japan’s QE programme has resulted in a substantial devaluation of the yen against the US dollar. However, this has not had the desired impact of increasing all exports to the world or the US in particular (Figure 3). Export-led growth has not materialised despite substantial QE-induced devaluation since the onset of Abenomics.




Figure 3  |  Monthly Value of Japanese Exports to the US vs. USD-JPY Spot, Last Price Monthly, June 2001 – December 2015
Source  |  DeltaMetrics 2015, Bloomberg


In fact, if anything, exports to the US from Japan have been falling ever since the start of the most recent phase of QE in Japan. Alongside this, Japan’s imports from the US have been increasing and could grow by nearly 5% in 2015 as a result of Japan’s greater external energy dependency after Fukushima.


4  |  Monetary policy is not the answer to trade and growth imbalances, but has unintended consequences

The US Fed is now in a bind: its challenge is not the monetary policy of its trading partners, it is the unforeseen consequences of its next monetary moves. The US dollar is strong and while some of this is because the US economy itself is doing well compared with other economies, its strength is more than partly due to the fact that markets are speculating on when the Fed will put up rates. Fuelled by both QE and uncertainty around the announcement of a rise in rates, it is likely that the USD and the euro will reach parity imminently, if not by the end of April then during May. Similarly, the yen is hitting new lows against the USD.

The euro and the yen’s values are already distorted by the effects of QE. Alongside this, any increase in interest rates will exacerbate the dollar’s strength against the currencies of all its major trade partners except China. While currencies weaken, equity markets including the Dax, Nikkei, the HSI and the Kospi continue bull runs that are the direct result of large amounts of liquidity made cheaper, not just by low interest rates, but also by weaker currencies. The result will undoubtedly be aggravated by a rise in US rates: a strong US dollar is not necessarily the best for the US in the long run if corporate earnings, confidence and exports falter.

Webcast 032 | Resurgent dollar is not good for business

The US Dollar has strengthened in March: Rebecca Harding discusses the consequences of a potential rise in US interest rates on emerging markets and the rise of the yuan as a major trade currency.


Webcast 032 Author  |  Rebecca Harding  |  CEO

Gold Trade: Why high demand for gold may be a good thing for India

Much of the recent attention regarding gold trade has been directed at China. This is entirely justified; rapid gold purchases from around the globe have fomented speculation that China is preparing to float its currency. But the truth is no-one really knows what they are planning to do. Their strategy is a manifestation of Deng Xiaoping’s famous maxim “hide your brightness, bide your time”. In other words, they will not show their strength until they can ensure they will achieve their objective.

Ambiguity and speculation over what is, undoubtedly, a very important question for global markets has meant that gold trade in other, highly significant, consumer nations has slipped under the radar. India, for example, currently ranks top in terms of largest gold consumer nations and in the past few years there have been shifts in policy.

Gold is an extremely popular commodity in India; it is as much a symbol of affluence as it is a means of providing future security. Demand for the precious metal has remained high. However, in recent years, India has struggled to balance this demand with its large trade deficit.

Policy makers were so concerned with the overall trade imbalance that in August 2013 the so-called 80/20 rule was imposed. This rule restricted India’s gold imports and forced 20% of any gold shipment to be re-exported by Indian jewellers. The 80/20 rule was scrapped in November 2014 after it became apparent that the domestic jewellery sector was suffering (Figure 1). Policymakers within India instead decided to focus on boosting exports rather than curbing gold imports.


Figure 1  | India gold jewellery market, 2008 – 2015, the impact of the 80/20 rule
Source | DeltaMetrics 2015


This is potentially a very shrewd shift in strategy; Delta Economics does not expect India’s demand for gold to abate with a forecast compound annual growth of 9.5% to 2020. Therefore, instead of cutting gold imports, which was leading to an increase in smuggling, February 2015’s budget suggested a scheme to monetise Indian citizen’s private gold holdings: an estimated 20,000 tonnes. The scheme would allow Indian citizens to accrue interest on any gold deposited into the banks. This could, as a consequence, reduce volatility in the rupee and provide the average Indian household with extra spending power.

At a time when the world’s national banks seem to be realising the potential of having a gold-backed currency, India’s historically high demand for gold suddenly doesn’t seem like such a bad thing.


Gold Trade: Why high demand for gold may be a good thing for India  |  Author  |  Jack Harding  |  Analyst and Publications Manager

Gold Standard

Three links that show the Yuan is ready to float  |  The value of the yuan against the US dollar is not making the headlines it should at the moment. Between the 17th and 20th March it appreciated by nearly 1%. Much of this volatility was arguably a response to the Federal Open Market Committee’s (FOMC’s) removal of the word “patient” from its statement on US interest rates. However, between the same dates, gold prices increased by nearly 3% prompting China to announce that the value of its currency against the US dollar was “appropriate”.

The occurrence of these three things within a week does not look like a coincidence, especially given that the Asian Infrastructure Investment Bank, first conceptualised in October 2013, acquired the support of the UK government, some European governments, the IMF and the Asia Development Bank during March 2015.

As China’s economy rebalances and becomes demand-led rather than export and infrastructure driven, it is in China’s interests to support trade in its neighbouring countries. This allows the region as a whole to develop by picking up some of the intermediate manufactured goods production that China can re-distribute through its own supply networks as it moves further up the manufacturing value chain.

Markets are markets and it is a mistake to conclude much from a few weeks of data. Yet it has shown how the re-focusing of China’s currency policy could have global market consequences. Currency policy is currently hidden within a multitude of different signals which appear to have converged during early March. China’s policy makers may be showing that they want to expose the yuan to international markets as they prepare for capital account convertibility. But they have also shown that they are preparing the yuan to establish itself in trade finance and indeed international markets as the second global currency.

There are three reasons for stating that the yuan is strengthening as a global currency: the first is trade, the second is the link between trade and the value of the yuan and the third is the link between gold and the value of the currency.

First, the link between trade and gold in China’s case is clear. Figure 1 shows how gold prices and China’s trade have moved together since June 2001 with a correlation of above 90%. The movements were almost identical up to the end of Q3 2013 when China’s trade starting slowing, de-coupled for 12 months to the start of Q4 2014 and have been similar for the last four months. February’s drop in gold prices mirrors China’s drop in trade and while this is clearly not causality, the closeness of the correlation is important.




Figure 1  |  Monthly Value of Chinese Total Trade (USDbn) versus XAU-USD Gold Spot Price, June 2001 – March 2015
Source  |  DeltaMetrics 2015, Bloomberg


Second, the correlation between Chinese trade and the value of the currency is similarly high at nearly 95%. However, interestingly, against the USDCNY spot (where strengthening of the yuan is shown by a downward trend) the correlation with Chinese trade is negative. In other words, despite a perception that the yuan’s value is artificial because of its 2% peg against the US dollar, the mild appreciation of the yuan since 2005 has not had a detrimental effect on trade (Figure 2). What this suggests is that the peg is helping to shore up the currency’s strength as trade develops rather than being managed to shore up trade.




Figure 2  |  Monthly Value of China’s Total Trade versus USD-CNY Spot, Last Price Monthly, June 2001 – December 2015
Source  |  DeltaMetrics 2015, Bloomberg


Further evidence of this is shown in the third link: between the value of the yuan and China’s trade in gold. The correlation is nearly 80%: that is to say that as the exchange rate has moved, so gold trade has increased (Figure 3).




Figure 3  |  China’s Gold Trade (USDm) versus USD-CNY Spot Price, Last Price Monthly, June 2001 – December 2015
Source  |  DeltaMetrics 2015, Bloomberg


Three things are immediately striking about Figure 3: first, gold trade only really started when the currency first appreciated against the US dollar; second, gold trade spiked when the initial 1% peg against the dollar was introduced in 2012; third, imports of gold started to increase sharply again from Q2 2013 as pressures for reform grew and the country prepared for its 18th CPC Central Committee Meeting in November 2013.


What all this suggests is that China’s currency policy is apparently a great deal more coordinated than it might appear at first. It is impossible to know exactly how much gold the country has and the values of trade in physical gold also underestimate total trade in gold which may come from barter or alternative forms (such as jewellery). However, alongside the increase in recorded trade in gold, China has been reducing its foreign currency reserves. This suggests that there is the potential for a large currency shift away from the dollar towards the yuan. The fact that gold reserves are increasing while foreign exchange reserves are falling suggests that policy makers are less concerned about weak Chinese growth and exports as they are about ensuring that, when the time is right, the yuan can enter a free-float against the dollar with impunity.

The links between trade, the yuan and gold all point in one direction: expect the gold price to increase, the yuan to strengthen and China’s exports to increase. China’s economy does not look like it is slowing – but it could just be setting a new Gold Standard.

China’s nerves of steel

Why January’s drop in exports may not be such bad news |  Chinese exports in January 2015 fell by 3.3% compared to a year earlier. Its imports fell by over 19%. Analysts had expected exports to grow by over 6% and the slowdown in imports to be less marked than it was. The Hang Seng Index (HSI), which has a high correlation with Chinese exports, dipped slightly on the news but had rallied by the end of the week.

Delta Economics views this rally as temporary: seasonal volatility in Chinese trade in January and February coupled with lower commodity prices means that we are likely to see a further drop in the value of China’s exports in February. Although the trend during the course of the year for the HSI is positive, lower trade could impact substantially on the value of the HSI until the end of Q1 2015 (Figure 1).




Figure 1  |  Monthly value of Chinese exports (USDbn) vs Hang Seng Index, LPM, June 2001-Dec 2015 (forecast)
Source  |  Delta Economics, Bloomberg


Of particular concern to analysts was the drop in imports in January. China’s trade is 83% correlated with oil prices and therefore the recent drop in oil prices goes some way to explaining the fall. Further, a more general drop in commodity prices would also have impacted on China’s import trade values for January: China’s trade is 61% correlated with steel prices for example. Given that we expect an increase of 5.8% in iron and steel trade in 2015, compared to 2.4% in 2014, it would be reasonable to conclude that seasonal effects and falling commodity prices are more likely to be responsible for January’s, and potentially February’s, drop in trade values rather than a drop in demand.

Iron and Steel trade is a good proxy for infrastructure development and economic growth within China. China is a net importer of Iron and Steel, the largest products within which are flat rolled alloy steel and hot rolled steel products. China’s exports predominantly go to emerging markets in Asia while China’s imports come from South Korea, Japan, Europe and the United States. China has a net trade deficit in iron and steel, yet to its key export partners, its market penetration is above average for the world.




Figure 2  |  Rebalancing of Iron and Steel trade
Source  |  Delta Economics, Bloomberg


The clearest indication of a reorientation of Chinese policy away from export and infrastructure-led growth in favour of demand-led growth can be found in its reimports of iron and steel. These are products that originate in China but are exported and then reimported from Chinese territories or Special Administrative Regions (such as Hong Kong, Macao or Taiwan). Over the past two years reimports have been slowing which suggests that China is utilising its internal resources less – arguably reducing its stockpiles.

Chinese trade, and particularly its iron and steel trade, matters for the rest of the world. But its importance is not as a proxy for the health of the Chinese economy. Instead, it matters because markets perceive it as a bellwether for the health of the Asian economy. For example, the HSI is 81% correlated with Chinese trade and 89% with the KOSPI. Similarly the Australian dollar’s correlation with Chinese iron and steel trade is 82%. While these do not reflect causality they do suggest that regional market sentiment and trade are strongly associated.




Figure 3  |  Monthly value of iron and steel trade (USDm) versus USD-CNY spot, Last Price Monthly
Source  |  Delta Economics, Bloomberg


Weaker trade data in the first part of 2015 is likely to result in a depreciation of the yuan (Figure 3). In recent months there has been a slight revaluation of the yuan but we see it depreciating further over the next two quarters as trade growth remains sluggish after it spikes in March. The correlation is negative at -82%: in other words, a currency depreciation will have a positive impact on iron and steel trade, because the currency elasticity of commodities is high.

This will have broader consequences for the rest of the world, not least by potentially aggravating trade relations between the USA and China by making US imports into China more expensive. It would also make European imports into China more expensive and, at a time when the European economy is looking to re-establish its growth, the importance of the Chinese market cannot be understated.

Once again this demonstrates the power that China has to manipulate its own performance and therefore to impact the economies of the rest of the world. Emerging markets equities are likely to react negatively to slower Chinese trade in the short term while the Australian dollar may well become weaker against the US dollar because it is so influenced by the performance of the Chinese economy generally and trade in particular.

If the yuan devalues further, this also has the potential to threaten any export-led growth that may be developing in Europe and the export-fuelled growth that the US is enjoying. The broader geopolitical risks of embarking on a currency war to protect China’s domestic interests as it restructures would stall trade negotiations at the very least. The hope is there will be no devaluation as China seeks to restructure its economy. The outlook for trade towards the end of 2015 and into 2016 for China is certainly brighter, but to get through the first quarter at least of 2015 markets and analysts will need to have nerves of steel.

Under the same Umbrella

Why Hong Kong protests will not have a lasting economic impact  |  Hong Kong’s so-called Umbrella Revolution will worry markets and strategists around the world while it continues; it may even deter a few tourists. There is a potential risk that once a largely younger generation has started to express its counter-establishment feelings, more protests might follow. All of this creates a degree of uncertainty and, in turn, potential for market volatility and reduced trade.

Delta Economics does not see the Umbrella revolution as having a lasting impact on trade or Hong Kong’s role as a financial centre. There has been a downward correction in the Hang Seng since July, although this is more likely to be because of wider economic conditions in Asia than specifically the protests in Hong Kong (Figure 1).



Figure 1  |  Value of Hong Kong’s exports (USDm 2001-2015) vs. Hang Seng Index,
Last Price Monthly, June 2001-September 2014
Source  |  DeltaMetrics 2014, Bloomberg


The correlation between the Hang Seng Index and Hong Kong’s exports is 0.823. This is very high and given a forecast decline in monthly trade export values up to 2015, suggests that the correction that we are currently seeing may have some way to go. However, as can be seen quite clearly from the chart these corrections are cyclical. Delta Economics expects exports in November 2014 will be 1.3% below their 2013 values. By January and February 2015 they will be similar to their levels 12 months earlier – unimpressive growth, but growth nevertheless.
The reason why the protests will have little impact on trade is the very reason why there are protests in the first place: the Umbrella Revolution’s purpose is to point out to the world generally, but China in particular, that it has the right to democracy as a counterpart to the free market and free trade system that it has built. It is not questioning the symbiotic economic and trade relationship with China, merely saying that the logical political consequence of a free market economy is the existence of a democracy.

Hong Kong’s exports to the United States, its second-largest export partner, are just 12% of the US$294bn it is expected to export to China in 2014; while exports to China will grow modestly in 2014, at just under 5%, they are forecast to fall to the US by nearly 3%. This point is reinforced by the fact that it is not just Hong Kong’s exports that are highly correlated (0.817) with the Hang Seng Index (Figure 2), but Hong Kong’s total trade with China as well (0.813).



Figure 2  |  Value of China’s exports to the world and value of Hong Kong’s trade with China (USDm),
June 2001-September 2015 vs. Hong Kong Index, Last Price Monthly, June 2001-September 2014
Source  |  DeltaMetrics 2014, Bloomberg

The Hang Seng moves proportionately with both China’s exports and bilateral trade between China and Hong Kong. Although the correlation is marginally weaker for Hong Kong’s trade with China than it is for either Hong Kong’s or China’s total exports to the world, it is still apparent that the Hong Kong Index appears more dependent on the trade relations between the two countries in the longer term than it does on political relations.

Hong Kong’s export trade is only mildly and negatively correlated with the Hong Kong dollar at -0.525. The Hong Kong Dollar is pegged to the US Dollar and is traded within upper and lower limits (Figure 3). However, a depreciation in the value of the Hong Kong Dollar at present appears to be aligned not just with the protests, but also with broader downward trends in trade (Figure 3).




Figure 3  |  Value of Hong Kong’s exports (USDm), June 2001-September 2015,
vs. USD-HKD Last Price Monthly, June 2001-September 2014
Source  |  DeltaMetrics, 2014, Bloomberg


The correlation between China’s exports and the value of the Hong Kong dollar is 1 per cent stronger, which underscores the fact that the dependency between the two countries works both ways. There is very little correlation between the value of the Shanghai Composite index and either Hong Kong or China’s trade (less than 0.34 in both cases) suggesting that the Shanghai Composite is more of a speculative market that the Hang Seng. However, the correlation between both China and Hong Kong’s exports and the value of the Yuan is extremely high at 0.885 and 0.941 respectively suggesting that China’s currency manipulation may have positive spillover effects for Hong Kong’s trade as well as China’s (Figure 4).



Figure 4  |  Value of Hong Kong and China’s exports (USDbn), June 2001-September 2015 vs. USD-CNY spot,
Last Price Monthly, June 2001-September 2014
Source  |  DeltaMetrics 2014, Bloomberg


Thus far the revolutionary impact of the protests has been limited. Indeed, there are signs that the numbers of protestors are dwindling. However, they have been successful in raising global awareness of the issue of democracy in Hong Kong and there is no guarantee that these protests will be an isolated event.

The protests highlighted the issue of how important Hong Kong is to Chinese and world finance. Markets were unsettled by events and investor confidence was knocked, however briefly. However, it is unlikely that there will be a lasting impact on long-term confidence, a weakening in the rule of law, or even a threat to the free-market and trade traditions of Hong Kong. After all, in the end the two countries are, economically at least, under the same umbrella.

Webcast 017 | Is volatility back?

Why markets need to price in geopolitical risk  |  July was again dominated by geopolitical risk and this seems set to continue through the summer months. Delta Economics expects market nervousness to build while global trade, which has already been disappointing in 2014, to remain flat, if not fall back further.  Delta’s Trade Corridor Index for the United States measuring how the trade climate changes month-on-month, is set to increase dramatically in August but fall back again in September and for the rest of the year.  Our TCI-based asset management strategy suggests that August will see an increase in volatility rather than a decrease.


Webcast 017 Author  |  Rebecca Harding  |  CEO

BRIC through a window

Why Russia’s attempt to decouple from the dollar is a defensive strategy  |  Gazprom’s decision to price oil trade with China in Roubles or Yuan rather than US Dollars effectively demonstrated the power that the BRIC countries want to exert over world trade. It has profound implications for trade finance, not least because a cry for decoupling emerging currencies from their dollar-dependency resounded across emerging Asia, and France, last week. The issue is that, as global pressure on interest rates in the US build and as tapering continues, the threats to Emerging Economies of US Dollar-denominated debt increases. It has not been a great year so far for Emerging Market currencies and the signals for a stellar recovery in the second part of 2014 are not strong.

France worries about this because of its increasing reliance on countries like Brazil for oil, and perhaps because it wants to bang the drum for the Euro. But Russia’s decision is arguably a defensive one – it is protecting its own oil trade interests with China as its relationships with Europe and the US become more strained. The value of the Rouble against the US Dollar is barely correlated with world trade, Chinese trade or even the oil price and, as a result, it is seeking to integrate itself into the world trade system through closer ties with China. The effect will be the strengthening of the Yuan, and ironically the Euro, as trade finance currencies and while it might serve to weaken the hegemony of the US Dollar in trade terms, it will have little impact on the value of the Rouble.

The reason for this is simple. There are two currencies that are very strongly correlated with world trade: the Yuan and the Euro, as shown in Figure 1.



Figure 1 | World export trade values (USDbn) versus USD-Yuan, Last Price Monthly, June 2001-June 2014
Source | DeltaMetrics 2014, Bloomberg


The correlation between the value of the Yuan and world exports is -0.91: in other words, as it weakens against the US Dollar, world exports increase and vice versa. This is of little surprise to any observer of world trade: the Yuan is a managed currency and it has been a bone of contention in trade negotiations between the US and China that its artificial weakness has kept Chinese exports strong. Indeed, as the currency has been allowed to strengthen over the past couple of years, world trade has slowed. This is not just simply a reflection of the dominance of Chinese exports in world trade. China’s trade is highly currency elastic – it exports intermediate manufactured goods that are very price sensitive and so trade will also be highly influenced by the value of its currency.

But there is more than just global trade at stake from Russia’s point of view. Russia needs to secure markets for its oil exports if it is to undermine the effects of first, any sanctions that may arise from the continuing crisis in Ukraine and second, the reduced dependency of Europe on Russian oil and gas. Its obvious trade partner is China and, indeed, Russian exports of oil and gas to China are forecast to grow annually by around 9% each year to 2020. China is resource hungry and, as a result, its trade is highly correlated with the oil price as well as with the value of its currency, as illustrated in Figure 2.



Figure 2  |  Value of Chinese exports versus NYSE Arca Oil Spot Last Price Monthly, June 2001-June 2014
Source | DeltaMetrics 2014, Bloomberg


The Rouble-Yuan currency spot is highly correlated with Chinese trade (0.75) and this potentially helps to explain why Russia is so interested in building up the ties between the two currencies through oil trade in particular. It strengthens the likelihood of the Yuan increasing its importance as a currency for trade finance and protects Russian trade interests against the weakness of the Rouble-USD exchange rate in other markets.

The only other currency where the correlations with Chinese trade, world trade and oil are as strong is the Euro, as Figure 3 suggests.



Figure 3  |  Correlations of major currencies with world exports, Chinese exports and the NYSE Arca oil spot price. June 2001-June 2014
Source  |  Delta Economics analysis, 2014


Apart from the strong correlations with trade and oil prices of the Yuan-US dollar price, the table also shows how important the Euro is as a trade currency. Past trade views have commented on the fact that the Euro is a trading currency that responds to economic fundamentals and not a currency that is used for speculation. Russia’s move towards the Yuan and away from the dollar will not strengthen the rouble, since its value against the dollar is barely correlated with trade and only weakly correlated with oil prices. However, it could serve equally to serve the purpose of strengthening the Euro as a trade finance currency.

The reason for this is because of the strong correlation between the Real-USD value and both world trade and Chinese trade and the oil price. While not as strong as the Euro value alone, there is something important that is emerging in terms of Brazil’s role in the trade finance system. Brazil’s exports to China are forecast to grow at above 11% for the next four years, and much of this trade is commodity-based – soya and oil in particular. Similarly, France’s imports of oil and gas from Brazil, for example, are set to increase in double digits annually over the next five years and exports to Brazil from Europe are forecast to grow at similar rates to exports to China over the next five years.

This helps to explain, perhaps, why there was a call from France in the last week to loosen ties with the US Dollar as well. Figure 4 shows that France’s trade is, in comparison with German trade, weakly associated with the value of the Euro versus the USD.



Figure 4  |  Correlations of key currencies against French and German exports, June 2001-June 2014
Source  |  Delta Economics Analysis, 2014


Perhaps more importantly, French exports are more correlated with the value of the Yuan versus the US Dollar, albeit more weakly than German exports. A logical conclusion is that it is in the interests of all exporters from the Eurozone for the Yuan to be a more dominant trade finance currency as it will help their trade, and hence the value of the Euro.

Russia’s move away from the US Dollar has a deep resonance across the trade finance system. First, it will encourage the Chinese government to decouple the currency from the dollar and allow it to trade in currency markets more freely which, in and for itself has to be a good thing for the global trading system. Second, it means that trade, and hence trade finance, will increasingly be denominated in Yuan, and arguably Euros as well, reducing the importance of the Dollar as a trade finance currency. Again, this is welcome on the grounds that it supports free trade.

And third, given the fragile relationship geo-politically between Russia and the US at the moment, it also makes it more important that the US engages in trade talks with Asia. If the Yuan and the Euro become more important as a trade finance currencies, then the US cannot afford to be isolationist in the way it handles its trade negotiations. Whichever way this is looked at, Russia has just thrown a BRIC through the window of the US’s current trade stance.