Yuan Won't Become the Global Fiat Currency Soon

Despite vastly inflated expectations for the Chinese yuan, inbound and outbound yuan payments have fallen below even below the Thai baht as a trade settlement currency - to 11th place in the global pecking order.

Many China experts have been forecasting that China's rise to become the world's second biggest economy would drive a concomitant rapid rise of the yuan to the forefront of trade settlement and the international currency trading business. They should be embarrassed. But it looks like it is going to be awhile longer before the yuan takes over as the world's fiat currency from the US dollar.

According to SWIFT, the firm that operates international payment systems between countries and banks, yuan payments have fallen back after having previously reached an all-time high. So although China is now encouraging the use of the yuan as a settlement currency, particularly in dealings with its immediate neighbors, the pace appears to have slowed even as China's trade values continue to rise.

In terms of currency trading, the yuan ranks somewhat higher - 8th place - thanks to foreign interest in its capital markets with the issuance of yuan denominated paper in offshore markets. Most of this - 62 percent - takes place in Hong Kong, with London having the lion's share of the remainder.

The opening of Shanghai's Free Trade Zone on Oct. 1 has been expected to drive up use of the yuan on an international level. The 28 sq. km. district has been designated as a pilot project for future financial reforms featuring liberalized interest rates, fewer restrictions on foreign direct investment and freer convertibility of the yuan. But capital flows are expected to continue to be restricted in and out of the zone in an effort to protect against China's massive capital flight, and there are few transactions, if any, that make the zone any freer than Hong Kong is now.

Although the yuan's share of global settlement and currency trading will likely resume its rise, the process will be very gradual. So long as China keeps tight controls on capital movement (and interest rates) the yuan can't become a major international currency. Given Beijing's emphasis on domestic stability, there is scant prospect of it taking risks and allowing its citizens to sell their yuan at will.

For the past decade there have been periodic forecasts that capital account convertibility would come about "within five years". It is probably now no closer than in 2005 - perhaps less so given the global trauma in 2008 and China's domestic credit expansion excesses since then.

Even the yen, despite decades of convertibility and the huge size of Japan's trade and investment, the use of the yen in trade transactions stalled a long time ago and is mainly the medium of Japanese companies. The yen has a major role in currency trading but only because of the openness of its capital markets - something China is no closer to, Shanghai FTZ or not Shanghai FTZ.

In regional trade, relatively stable currencies not subject to stringent exchange controls can be at least as attractive as the yuan. The Singapore dollar stands out but the baht is also well accepted by its neighbors for trade purposes.

The assumed future declines of the role of the US dollar and also the euro (and pound sterling and Swiss franc) may well end up benefitting currencies of the most open and stable economies rather than China - or other BRICs. Neither Russia, Brazil nor India have the banking, regulatory or market systems to be acceptable to others.