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 China's
currency isn't about to replace the US dollar as a fiat
currency any time soon
Much has
been made, particularly in Hong Kong, of China’s decision last
week to allow settlement of certain cross-border trade in yuan. For
sure, this is a step forward towards full convertibility which would
increase the role of the nation’s currency. However, the notion
that it will significantly reduce the role of the US dollar in trade
transactions except in the very long term is dubious. Indeed, China
has good reason not to want to see its currency in demand outside its
borders, flattering though that might be.
China in
fact could well look at the failure of the yen to play a larger role
in trade despite many years of full convertibility and the enormous
role that Japanese companies have played, and continue to play,
globally. Indeed, if China wants to get away from dollar dependence
it might do well to encourage more invoicing in the only two
currencies which currently provide a realistic alternative –
the euro and the yen.
China’s
pilot project is to enable Hong Kong, Guangdong and Yangtze delta
firms to use yuan in settling trade transactions. Likewise, the same
will apply to firms in Yunnan and Guangxi in dealings with Asean
neighbors – which for practical purposes means Laos, Burma,
Vietnam and Thailand.
The
Chinese announcement has been greeted by many in Hong Kong as another
benefit given to the territory to help it through the crisis. But
that does not seem to be Beijing’s real aim, which is more of
an experiment that to some extent simply recognizes existing
realities in the same way the Thai baht is sometimes used for border
trade with neighbors with uncertain currencies. The yuan is already
in limited use across both of the borders concerned at least for cash
transactions, which can be on a large scale. It is however unlikely
that the yuan will be used for the majority of Hong Kong-Guangdong
trade because most of that relates to transshipment and processing
trade with third countries, which will continue to be largely
denominated and settled in US dollars.
Back in
the late 1980s, it was often assumed that the yen would gradually
become more important in trade, especially in Asia as a significant
portion of Japan’s exports were invoiced in yen, a currency
then becoming more important in other countries’ foreign
exchange reserves. But yen usage stalled and never became widespread
in trade between third countries. Reasons for this included the
emergence of China, which was both reluctant to give face to Japan
and anyway kept its currency pegged to the dollar and its exporting
goals focused on the US.
In any
event, Japan feared that making it easier for the yen to play a
larger role would tend to push up its value at a time when Japan was
trying to counter the deflationary impact of the yen’s huge
rise between 1985 – when it averaged 240 to the dollar –
and its 1995 peak of 85.
The yen’s
tendency to appreciate excessively made the Bank of Japan reluctant
to make its easier for foreign central banks to hold and trade
yen-denominated paper. Thus the role of the yen in international
reserves tended to decline. Other countries by extension preferred to
stick with relationships with the dollar, thus making it unnecessary
for them to encourage financing trade in any other currency. Even the
collapse of fixed exchange rates at the time of the Asian crisis did
not change that.
There is
unlikely to be any significant non-local use of the yuan while it is
otherwise not convertible and does not feature among foreign currency
reserves. Nor is there any reason for China to encourage that while
it is running a huge current account surplus and has far bigger
dollar reserves than it needs.
A more
immediate way to increase international usage of the yuan without
adding to its foreign reserves would be the issue of offshore bonds
which would be denominated in yuan but as buyer and borrower were
both offshore the net impact would be zero. As Singapore has shown it
is possible to develop an own-currency offshore market without losing
control of the either the currency or local interest rates. Another
possibility would be to allow foreign borrowers to issue yuan bonds
to Chinese domestic investors – Panda bonds, a Chinese version
of Japan’s Samurai issues. Two were issued earlier – by
the International Finance Corp and the Asian Development Bank -- but
on the understanding that the funds would be used locally not
repatriated.
Now
however China may be more willing to allow capital outflow with the
proceeds of issues swapped into other currencies. In that way local
institutions would acquire yuan denominated assets whilst official
dollar reserves would fall.
Mainland
institutions may be ready for such investments this but given the
recent turmoil in global financial markets the Chinese authorities
may be reluctant to encourage an developments which increase
financial flows and hence carry the risk of adding to currency
instability and pressures on domestic monetary policy.
As with
most aspects of China’s liberalization, all steps to increase
use of the yuan will be cautious and cumulative and – whatever
the Hong Kong government likes to claim – be motivated by the
government’s perception of overall national interest.
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Economics/Business 
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