Millions of investors are hunkered down over fears that the US dollar will lose 30% to 50% of its value in the upcoming months, as a result of the Chinese yuan becoming a "reserve currency."
There's no reason to join them in the proverbial bunker.
In fact, quite the opposite is true – and that's why I want you to go on the offensive.
Starting with these three choices.
What It Means to Be a Global Reserve Currency
If there's one thing I've learned over the years, it's that financial predictions are a lot like belly-buttons… in that everybody has one. Most are highly provocative, simply because that's how the pundits and tipsters grab your attention.
Very few actually come to fruition, which is why it's almost always more profitable to take the other side of the equation.
Case in point, take the Chinese yuan, or "renminbi" as it's also known, which means "people's money."
There's been no end of hype about how that nation's money would crater the U.S. dollar when it became a "reserve currency." And it's reached a crescendo over the past few months.
Admittedly, the arguments sound plausible. No doubt, that's why they're so scary.
The stream of thought usually goes something like this… global trade has shifted, China's economy dominates world markets, they'll start a currency war as a means of ensuring that China stays on top… all of which culminates with some variation of the U.S. dollar will crash by 30% to 50% when everybody starts selling it.
When you dig deeper, though, the story just doesn't hold up. Frankly, neither do most of the "experts" I might add, but that's a story for another time – very few of them understand how global financial markets actually work.
Let's start with what it means to be a "reserve currency."
Technically speaking, a reserve currency is a currency held in huge quantities by central banks and governments as part of their foreign exchange reserves. Usually that's because the nation holding it does so much trade that they need it to pay liabilities or manage ongoing trade relationships.
The press would have you think that the U.S. dollar is the world's reserve currency. In fact, reserve currencies come and go over time.
Twenty-five hundred years ago it was the Greek drachma. Then there was the Roman denari, the Byzantine solidus, and Arab dinar. The Middle Ages saw the rise of the Venitian Ducato and the Florentine. By the mid-1800s, the world operated on the gold standard and more than 60% of global trade was invoiced in British pound sterling.
Prior to WWI, there were three reserve currencies – French francs, German marks, and the British pound sterling. After WWII, U.S. dollars replaced German marks.
Today there are actually seven world reserve currencies: U.S. dollar, euro, pound sterling, Japanese yen, Canadian dollar, Australian dollar, and a small mix of others.
The U.S. dollar presently makes up 63% of total currency reserves, while the euro accounts for 21%. That's followed by the pound sterling, Japanese yen, and Canadian dollar with about 4%, 3%, and 2%, respectively.
The fear mongers say that's terrible because it means the dollar could shrink if everybody starts selling. They crow that 63% percent is a big number that's just got to fall.
Well, where? And to what level?
What the doomsayers do not understand about how real money works, is that the world's traders cannot sell U.S. dollars en masse, even if they want to, because there is not another reserve currency capable of absorbing the liquidity.
Put another way… imagine the U.S. dollar is the water in a gallon milk jug and the euro is a tiny one-pint container. You cannot simply pour all your dollars into the pint-sized euro container because it's only so big. You've got to get another container…
Enter the yuan.
Last Saturday, it joined the International Monetary Fund's basket of reserve currencies known as Special Drawing Rights – SDRs for short – which determines which currencies countries can elect as the basis for their IMF loans.
Obviously the U.S. dollar didn't crater, and our financial markets are not a smoldering hole in the financial landscape. It's no coincidence that those same "experts" are eerily quiet at the moment.
Which brings me to how you can profit.
More than 30 countries already have Chinese swaps worth in excess of 3 trillion yuan.
First, bankers are going to stock up on yuan.
The IMF has assigned the yuan the third-largest weighting of five total currencies in its basket, and that means central bankers around the world have to have more yuan on hand to match the allocation.
People constantly scream that China is a currency manipulator, but what they don't realize is that inclusion in the SDR basket means more transparency for China. Not less. So China will have to play by the rules.
Second, the yen and the British pound sterling are actually the currencies most at risk. Neither will disappear, but both will gradually fall by the wayside as global trade increasingly prices in yuan.
And third, watch for Chinese yuan-denominated debt to be included in commonly cited government and corporate bond indices like JP Morgan's CEMBI and EMBI market indices. Other global indices like MSCI and EAFE will change, too, as those relationships, in turn, affect stock prices.
Unbeknownst to most investors, the yuan is already the fourth most liquid currency in the world. That's logical when you think about it. Only 3% of the world conducted trade in yuan in 2010, according to ETF Daily News. Today that figure is 50% and rising.
Washington views the dollar as a weapon but what they don't realize is that huge swathes of the world believe it's a liability. You will see everything from oil to soybeans priced in yuan as time goes on.
Over the last several years, many countries, especially those in East Asia, have stopped using the U.S. dollar for trading purposes. Instead, they've chosen to bypass the dollar and engage in bilateral trade agreements and currency swaps.
In case you're not familiar with the term, a currency swap is a one-to-one agreement between two countries to trade in their own currencies that bypasses traditional currency markets.
China has already signed hundreds of these deals with more than 30 different countries since 2008, with a total value of more than 3 trillion yuan. And these aren't just third world, banana republics either, as you can see from the following chart.
Most of Europe's on board, including Germany, France, Switzerland, and Hungary. Count much of South America in, and many African countries, too.
Even the European Central Bank (ECB) is on board. Team Draghi signed a currency swap agreement with the People's Bank of China (PBoC) three years ago and just renewed the deal last week.
Again, almost nobody is selling U.S. dollars but, sure as hell, they're buying yuan.
According to Forbes and the People's Bank of China, foreign investors purchased $14 billion worth of yuan-denominated debt in Q2 2016 alone – a figure I believe will triple when more current numbers are released.
The simplest way to play along is with a fund like the WisdomTree Chinese Yuan Strategy Fund (NYSE Arca: CYB), which provides direct exposure to the yuan itself.
A slightly less direct way to get on board, but one that will prove every bit as profitable, and then some, is a choice like the PowerShares Chinese Yuan Dim Sum Bond Portfolio (NYSE:DSUM). This fund invests at least 80% of its assets in yuan-denominated bonds that are settled outside mainland China, generally through Hong Kong.
And, finally, consider companies like Starbucks Corp (NASDAQ:SBUX). Apple Inc (NASDAQ:AAPL) and McDonald's (NYSE:MCD) Corp., all of which have a huge vested interest in China's growth.
The play here is not just performance, which will obviously accelerate as 660 million Chinese join the middle class and propel the country still higher, faster, and farther.
What you're really looking for is the fireworks that will happen when those companies, and many more just like them, list on Chinese exchanges at some point in the future.
Most investors find that inconceivable, but so were ADRs when they first came on the scene in 1927 and American investors suddenly had access to powerful foreign corporations without the hassles of buying shares in overseas markets.
Let me close with one final thought.
Most doomsayers want you to believe that whatever disaster they're promoting is an instant event when, in fact, things hardly ever work out that way.
Currency shifts by their very definition are longer-term events. So you've got to play them that way by moving your money to align with China's money ahead of time.
Before everybody else figures out what's at stake.
I'll be with you every step of the way.