THE YUAN AND CHINA'S YUAN POLICY

VALUE OF THE YUAN

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In 1996 Chinese currency became convertible but strict controls made it difficult to covert the yuan to other currencies and visa versa. The value of the yuan was fixed at a rate of 8.3 yuan to the dollar between 1994 and 2005.To keep the yuan from rising against the dollar the central bank buys most of the foreign currency that flows into the country from exports and foreign investment from the country’s commercial banks and exchange them to yuan. To prevent these funds from entering the financial system and fueling inflation, the central bank issues treasury bills to financial institutions.

In 1994, China cut the yuan’s value by 30 percent and adopted a managed float system. In 1997, during the Asian financial crisis, the yuan was pegged to the U.S. dollar. The exchange rate for the yuan was 7.97 in 2006, 8.19 in 2005, 8.27 in 2002, 2003 and 2004.

Many outsiders want to see the yuan float, so that it reflects its true value and makes Chinese goods and labor more expensive. They argue the low yuan gives Chinese enterprises an unfair advantage and makes it hard for manufacturers in other countries---unable to match the low prices of Chinese imports---to compete. The U.S. Secretary of the Treasury has traveled to Beijing specifically to win concessions on this issue but has only been given vague promises that the yuan will be allowed to float freely sometime in the future.

The value of the yuan is set by the State Council not the central bank. The Chinese government is worried about freeing up the movement of currency across borders, fueling speculation boom like the kind that lead to Asian economic crisis in 1997. It also argues it needs to gets in banks in order before it can allow the yuan to float; it needs to maintain growth to offset job losses in the state-owned enterprises; and currency stability benefits not only China but every country that trades with China.

In April 2006, the Chinese government issued regulations that made it easier for Chinese to invest abroad and Chinese companies to buy foreign exchange. The move was expected to cause more outflow of foreign currency and decrease upward pressure on the yuan.

Websites and Resources

Good Websites and Sources: 2008 Library of Congress Report on Sovereign Wealth Funds pdf file fas.org/sgp/crs ; Wikipedia article on China Investment Corporation Wikipedia ; New Bureau of Asia Report in Understanding China’s Sovereign Wealth Funds pdf file nbr.org/publications ; Macroeconomics: China Macroeconomics Information Network macrochina.com.cn ; Paper on Macroeconomic Policy, a Case Study 2006 PDF File University of Tokyo ; Macroeconomics, Inequality and Poverty networkideas.org

Good Websites and Sources on Economics in China: Wikipedia article on the Economy of China Wikipedia ; Asian Development Bank adb.org/PRC ; World Bank China worldbank.org ; International Monetary Fund (IMF) on China imf.org/external/country/CHN ; China Economic Information Office cei.gov.cn ; ; U.S. Commerce Department’s Office of China Economic Area (OCEA) export.gov/china ; Statistics: China’s National Bureau of Statistics stats.gov.cn/english ; Chinability Blog chinability.com/ ; Nationmaster nationmaster.com ; Money Chinese Coinage Website www.charm.ru ; Chinese Money in the 20th Century PaulNoll.com ; Chinese Banknotes chinatoday.com

Economic News The Economist on China economist.com ; China Economic Net en.ce.cn ; China Economic Review chinaeconomicreview.com ; Far East Economic Review feer.com ; Economic and Business News Related to China jlmpacificepoch.com ; China Daily Coverage of Economic Issues chinadaily.com.cn ; Financial Times China ft.com/world/asiapacific/china ; China Perspective thechinaperspective.com ; China Economics Blog china-economics-blog.blogspot.com ; Economic Policy: OECD Economic Survey of China, 2005 PDF file oecd.org/dataoecd ; Book: Frontiers of Economics in China, A Collection of Papers http://www.springer.com/economics/journal/11459 ; McKeever Institute’s Economoc Policy Analysis mkeever.com ; Council of Foreign Relations www.cfr.org

Links in this Website: BASIC ECONOMIC INFORMATION ON CHINA Factsanddetails.com/China ; MACROECONOMICS AND ECONOMIC POLICY IN CHINA Factsanddetails.com/China ; THE YUAN, FOREIGN RESERVES AND SOVEREIGN WEALTH FUNDS IN CHINA Factsanddetails.com/China ; CHINESE REGIONAL ECONOMICS Factsanddetails.com/China ; EARLY ECONOMIC HISTORY IN CHINA Factsanddetails.com/China ; DENG XIAOPING'S ECONOMIC REFORMS Factsanddetails.com/China ; ECONOMIC HISTORY AFTER DENG XIAOPING Factsanddetails.com/China ; GLOBAL ECONOMIC CRISIS OF 2008 AND 2009 IN CHINA Factsanddetails.com/China ; BUREAUCRACY, WELFARE AND TAXES IN CHINA Factsanddetails.com/China ; LOCAL GOVERNMENT IN CHINA with a section on TVEs Factsanddetails.com/China ;

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front of 100 yuan banknote

Revaluation of the Yuan

In 2005, China revalued the yuan by 2.1 percent against the U.S. dollar, abandoning the peg against the dollar, and allowing the yuan to float against other currencies such as the yen, dollar and euro, and allowing it to float within 0.3 percent of the dollar a day using “baskets” of foreign currency---a technique mastered by Singapore.

The reevaluation had been anticipated for a long time. It was the first revaluation in 10 years. The adjustment was minor but was regarded as a first step because the yuan was still considered way overvalued. Many regarded the move as more political---to appease critics that had demanded a yuan devaluation---than economic.

The revaluation of the yuan changed the value of the yuan from 8.277 yuan to the dollar to 8.110 yuan to the dollar. The United States had been calling for a revaluation of 10 percent and been threatening to slap a 27.5 percent tax on Chinese imports.

The move was widely received positively around the world. Stock markets around the globe rose. Inventors welcomed the news as a sign of things to come more than on changes brought about the revaluation itself, which were modest.

The impact of the revaluation on the United States was minimal. Prices on Chinese goods were not expected to rise high enough to deter shoppers of do anything the United States’s trade deficit. Analyst said that a revaluation of around 10 percent would be necessary for there to be really significant changes.

A World Bank study has estimate that the value of the yuan will be 5.8 to the dollar in 2010 and 2.8 to the dollar in 2020. As the value of the yuan strengthens Chinese-made gods will be more expensive, Chinese labor costs will be higher and profit margins for foreign companies with facilities in China could shrink. At the same time foreign products will be cheaper in China and there will be more incentive for Chinese to buy them. If costs in China become too high, foreign investors might invest their money in other places were labor is cheap and costs are low.

Responding toe criticism of China’s slow pace of reform and failure to change the value of the yuan, one Chinese official, a deputy governor the Bank of China, at the World Economic Forum in Davos, Switzerland, told his critics to back off and “clean you own houses first.”

After the Revaluation of the Yuan

The yuan appreciated steadily against the dollar. In the first year after the re-evaluation it had not risen more than 0.15 percent on one day, half the maximum of 0.3 percent, and gained 0.9 after one year. The value of the yuan broke the 8 yuan to a dollar mark in May 2006 and rose to 7.81 per dollar in January 2007, rising in value by more than 6 percent since July 2005. The yuan broke the 7.5 to the dollar mark in October 2007. The yuan rose around 9 percent in 2007 and 4.4 percent in the first three months of 2008. The value of the yuan rose in 2006 partly out of the strength of the Chinese economy and partly out calls from Europe and the United States for it to reflect China’s trade surplus. Chinese officials also began have concerns that a low yuan might unleash inflation. The value of the yuan rose further in 2007 as the dollar weakened.

Yuan rose 18.5 percent against the dollar between July 2005 and November 2008. At the end of 2007, the yuan began appreciating at its fastest rates since the of the peg to the dollar was ended in 2005, at one point rising in value at almost 1 percent a week. The change was largely the result of China’s effort to tackle inflation at home. In April 2008 the yuan rose past 7 to the dollar for the first time since the fixed exchange rate ended in 2006. The yuan rose around 9 percent in 2007 and 6.9 percent in the first sixth months of 2008.

Between July 2008 and June 2010 the yuan was pegged to the dollar with a value of 6.83 yuan to the dollar. It stayed tied to the dollar when the dollar plummeted in value, and as result lost value against currencies that were stronger at that time such as the Brazilian real and South Korean won, which gained 42 percent and 36 percent respectively against the yuan as of late 2009.

The yuan is still highly undervalued. This helps create trade surplus by making exports relatively cheap and imports expensive. The United States considered charging China with currency manipulation, undervaluing the yuan by as much as 40 percent, a move that could lead to trade sanctions if the WTO agreed with the charges.

Based on moves made in the past few years, it seems likely that Chinese officials will let the yuan, which is pegged to the dollar, rise by 2 percent to 3 percent against the greenback each year. To keep the yuan undervalued China has to buy dollars to prop up the dollar’s value. Buying dollars means exchanging them for Chinese currency and flooding China with yuan, which normally causes inflation which the Chinese government avoids by issuing bonds to take yuan out of circulation, a process the Chinese call “sterilization.” Interest rates are kept artificially low to keep investors from buying Chinese currency. The artificially low interest rates make it impossible for Chinese to control monetary policy. This means that loans to companies does not reflect their real value, which could create a bubble situation.. The United States and other want China to float the yuan.

When ever statistics released that show high growth rates and high trade surpluses for China there is pressure on China raise the value of the yuan, especially from the United States. See U.S. Pressure on the Value of the Yuan, See Macroeconomics

In 2007 the yuan gained more than 5 percent against the dollar and lost more than 5 percent against the Euro. It was valued at 7.42 yuan per dollar in November 2007.

Undervalued Yuan

Most analysts estimated that the yuan as of 2010 was still undervalued by 25 to 40 percent, which gives China a huge advantage in international trade. U.S. manufacturing groups blame the Chinese currency for a loss of more than 1 million jobs. If the United States formally labels China a currency manipulator it can claim that China uses a low-valued yuan to give it an unfair trade advantage and the yuan can be treated as subsidy that boosts duties on Chinese imports.

Non-Chinese have argued that a stronger yuan will not only help foreign countries it could benefit China by reducing its reliance on exports and generate strong demand at home, which some argue marks the path for more stable sustainable growth in the future. According to the Economist: “In the long run, a stronger yuan would benefit China’s economy---and the world’s---by helping shift growth from investment and exports towards consumption. It would boost consumers’ purchasing power and squeeze corporate profits, which have accounted for most of China’s excessive domestic savings.”

How to go about increasing the value of the yuan is a matter of some debate. Increasing its value slowly would encourage speculators and create dangerous hot-money inflows. Raising it in a dramatic one-off increase would put many exporters out of business overnight.

According to the Economist: “Some Chinese economists warn that the benefits to the United States for the yuan revaluation are much exaggerated. In particular, a stronger yuan would not significantly reduce the U.S. trade deficit. There is little overlap between U.S. and Chinese production, so U.S. goods could not simply replace Chinese imports. Instead, consumers might end up paying more for imports...This would be like imposing a tax on U.S. consumers.”

Impact of a Low-Value Yuan

The value of the yuan is controlled by the government. China’s economic growth has been helped by the low value of the yuan. With the yuan low, the price of Chinese products and labor remains low, spurring the purchase and export of Chinese-made products and attracting foreign investment to take advantage of cheap labor, stimulating growth. Beijing wants to keep the value of yuan low to keep the economy humming.

Historian Francis Fukuyama wrote in a Global Viewpoint column, the Chinese are “basically giving their whole coastal manufacturing region a big advantage over the rest of the world by keeping their currency pegged to the dollar at its current rate...China’s de facto export subsidy via its currency policy is theoretically no different from a direct subsidy to its manufacturing, export industries...In a certain sense, China has been in effect de-industrializing much of the rest of the world. I’ve been to the maquillas in Latin America...and seen first hand how manufacturing capacity is being sucked out of these developing countries.”

A lot of advantages that China and Chinese companies have stems from the low value of the yuan. Some Chinese economists view the economic stagnation that occurred in Japan to be the result of letting the yen appreciate too rapidly during boom times---and they don’t want China to make the same mistake.

China’s huge trade surpluses put pressure on the yuan to rise in value. To keeps the yuan’s value from rising the government buys large amounts of dollars.

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back of 100 yuan banknote

Pressure to Increase the Value of the Yuan

A study by the U.S. Treasury Department in 2008 determined the yuan “remains substantially undervalued” but that China failed to meet the legal definition for country that manipulates exchange rates.

In June 2007, the U.S. Senate unveiled a bill intended to force the Chinese to raise the value of the “undervalued” yuan. The bill was announced at a time when the U.S. trade deficit with China was at an all time high. Among other things the bill proposed coordinated currency intervention by the Federal Reserve Board and other central banks. The bill came after efforts by U.S. Treasury secretary Henry Paulson visited Beijing to persuade China to raise the value of yuan came up empty. China has responded to threats with assertion that the value of the yuan is not the main reason for the United States’s trade deficit and the United States should ease it export regulations of high-tech items.

If the value of the yuan were to rise 30 percent like some American politician want, it could cause deflation, cut economic growth, cutoff foreign direct investment. If these things happened prices would skyrocket at Wal-Mart and Best Buy, consumers would stop buying the stuff, and the Chinese and Asian economies would grind to a halt but would have the money and reserves to buy America’s largest corporations.

If the value of the yuan were to rise significantly, the change probably wouldn’t affect the U.S. deficit or the trade deficit or bring jobs back to America. If Chinese imports become too expensive manufacturers will shift location in Asia to, say, Vietnam or Indonesia. With less cash China would not be able to buy U.S. treasury bonds and this could lead to a rise in interest rates in the United States. If the purchasing power of the Chinese grows with a stronger yuan they will buy more commodities such as oil and cause the price of these commodities to rise and snatch American companies and possibly buy up properties as the Japanese did in the 1970s and 80s.

Leaders in Europe and the IMF have also said that a stronger yuan is needed. But if anything pressure o China to act on the yuan only seems to make China more committed to digging in its heals and refusing to budge. Some argue that the easiest way to get China to raise the value of the yuan is shut up about it.

In June 2010, just before major meetings of the G-20 and G-8 as pressure was mounting on China to do something about the weak yuan, China promised to allow more flexibility in the yuan’s valuation and it removed the yuan from its 23-month peg to the dollar. The move was seen by some as the biggest shift in currency policy in two years. The value of the yuan reached 6.79 to the dollar, the strongest it had been since the peg on the dollar was dropped in 2005. But still the value of the yuan didn’t rise by all that much and critics of the yuan policy in Washington continued with their demand for a significant hike in the value of the yuan.

In September 2010, U.S. Treasury secretary Timothy Geeithemer hardened his position on the yuan value issue---perhaps because an election was coming up---and said it was time for China to move faster to increase the value of the yen. The same month, the U.S. Congress passed a bill 349-79 with bipartisan support that said the low-valued yuan could be treated as subsidy, opening the way for the United States to place additional duties on Chinese imports. A few days before U.S. President Obama made a personal plea to Chinese Premier Wen Jiabao for China to change to yuan policy.

In response China has called the weak dollar and low United States interest rate a threat to the global economy. It also said China should be given some credit for holding the currency steady against the dollar during the 2008-2009 global financial crisis when the value of the yuan rose against every currency except the Japanese yen and be praised for generating growth during the crisis making it less severe than it otherwise might have been.

Legislation to pressure China to let the yuan rise in value passed the U.S. House of Representatives in 2010 but died in the Senate. After Hu Jintao visted the United States In January 2011, U.S. lawmakers wanted the revive the bill. One bill passed the Senate in the fall of 2011 but nevr made it to the House.

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front of 50 yuan banknote

Prodding China to appreciate the undervalued yuan was a hot political issue in the United States in 2010. Some congressmen wanted the Obama administration to raise tariffs on Chinese-made imports and label China “currency manipulator.” In the end Obama decided not to attack China too aggressively on the issue so as not to stir up too much animosity. In one-on-one meetings with the Chinese leader Hu Jintao, Obama prodded him to allow the yuan to appreciate. Beijing responded that it would not bow to foreign pressure and called such pressure “political myopia.”

Not everyone thinks raising the value of the yuan will help the world’s businesses and economies. William Pesek of Bloomberg described three ways a strong yuan could backfire: 1) it could accelerate inflation by raising prices in the “Wal-Mart economy” that the world has come to depend for a steady stream of cheap good; 2) it could produce a slowdown in the Chinese economy that could deprive the world of a much-needed growth engine; and 3) it could make China so rich and flush with cash that it could snap up major corporations and chunks of choice real estate in a way that the Japanese shopping spree of the 1980s would seem like a trip to a convenience store. When Japan allowed the yen to double in value in the 1980s its trade surplus for the most part didn’t change.

Some analysts have argued that the best way to get China to budge on the yuan issue is for developing countries, especially those in Asia---arguably the ones whose manufacturing sectors have suffered the most from a low-value yuan---to put more pressure on China to raise the value of its currency.

China Widens Yuan Trading Band vs. Dollar in April 2012

April 2012, Esther Fung and Shen Hong wrote in the Wall Street Journal: “China will allow the yuan to trade in a wider daily range against the U.S. dollar, another major step in liberalizing its exchange-rate regime and making its currency more market-oriented. Effective soon after it was announced the yuan's new trading band against the dollar will allow the exchange rate to move as much as 1 percent above or below a daily reference exchange rate, the People's Bank of China said. The band has been 0.5 percent above and below since May 2007, when it was stretched from 0.3 percent. [Source: Esther Fung and Shen Hong, Wall Street Journal, April 14, 2012]

“The widely anticipated widening comes as the yuan's immediate outlook seems murky and pressures for China to allow it to appreciate have eased substantially. Recent data show the country's trade becoming more balanced, perhaps marking the end of an era when inexpensive labor and a cheap yuan helped Chinese goods flood the globe, creating consistent huge trade surpluses. China recorded a $5.35 billion trade surplus in March, with sluggish export growth, after a $31.48 billion deficit in February. [Ibid]

“Senior officials, including Premier Wen Jiabao and China's central banker, have hinted strongly in recent months that the yuan---which they argue is nearing fair value---would be allowed to trade in a wider range. The decision also followed data showing that first-quarter growth in the world's second-largest economy was the slowest in three years, a development that calls for further policy easing. China's economy grew at 8.1 percent clip, short of expectations and well off from the previous quarter's 8.9 percent. [Ibid]

“Concerns about a hard landing for the Chinese economy have contributed to much greater volatility in recent months for the yuan, which has been sent to its downside band limit by heavy selling numerous times. For the year, the yuan is down 0.14 percent against the dollar. It remains well up for the period since June 2010, when Beijing effectively depegged the yuan from the dollar. Its accumulated gain for that period is 8.3 percent. [Ibid]

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back of 50 yuan banknote

Raising the Value of the Yuan Helping China?

The IMF and the United States and other countries are encourage China to raise the value of the yuan and use its vast reserved to improve the purchasing power of Chinese and curb inflation. If ever there was time to raise the value of the yuan late 2010 and early 2011 when China was posting high inflation and facing property and asset bubble all things a higher yuan would help remedy.

In June 2010 China said it would allow the yuan to rise and did so by about three percent through the fall. China was praised for letting this happen. Then the movement stalled. One Obama administration official told the Washington Post this showed that China’s export lobby still called the shots. For their part the Chinese put some of the blame on stimulus measures by the United States that was largely financed by the sale of bonds that were largely purchased by China.

Some economist advocate a free-floating yuan and argue a major revaluation upward of the Chinese currency wouldn't signal a crisis for exporters. He believes any loss to profit margins would be more than offset by cheaper costs for labor and raw materials. Yet that argument has little sway over others tied to China's powerful manufacturing sector.

Benefits of a Strong Yuan

Liberalizing the yuan eventually and letting it appreciate will help with two of Beijing's most pressing priorities---controlling inflation and giving its vast middle class more buying power. [Source: Kopin Tan, Barron’s, November 14, 2011]

Having a strong, easy-to-exchange yuan and a market that investors can easily buy in and out of has many advantages: 1) Investors, banks, governments are more willing to hold your currency and bonds; 2) You can practically print money to buy foreign assets, and investors essentially extend to you an interest-free loan; 3) You can issue debt to finance myriad investments; 4) Your financial markets end up deeper than they might be otherwise, which makes your banks more competitive; 5) And, conducting overseas trade in your own currency avoids risks that come with fluctuating exchange rates, giving your companies greater bargaining power.

None of these attractions are lost on Chinese bankers and businesses, and Beijing sees plenty of room to grow. For example, just 8.6 percent of China's trade was settled using the yuan in the first half of this year. That's already a big jump from 0.7 percent in the first half of 2010, but pales compared to levels exceeding 50 percent for the euro zone and 80 percent for the U.S. Not surprisingly, China is steering trade partners toward the yuan.

China’s Power in the International Currency System

The Chinese are behind an international movement that gained momentum during the economic crisis in 2008 and 2009 to find alternatives to the dollar as the dominant global currency. In December 2008 China signed an agreement with several Asian countries to settle trade payments in yuan rather than dollars and encourage these countries to keep yuan in their foreign reserves. This was seen as step to making the yuan more freely convertible. Zhang Ming, secretary general of international finance at the Chinese Academy of Sciences, told Bloomberg, “China has learned from the financial crisis that we must reduce our reliance on the dollar and promote the yuan as a regional or international currency.”

Chinese President Hu Jintao hasd called the dollar-based international currency system a “product of the past”. China has moved to makes it currency convertible on to international markets. During the global economic crisis, and partly motivated about concerns about its large dollar holdings, China began making is easier for trading partners to conduct business in yuan rather than dollars. Currency swaps were conducted with nations such as Argentina, Belarus, Hong Kong, Indonesia, South Korea and Malaysia.

China’s official currency reserves are becoming so large that some worry China will be able to manipulate exchange rates and set trading ranges for currencies such as the dollar and euro. Ricard Barbieri Hermitte, an independent economist and market strategist, wrote for Bloomberg in 2010, “If China’s reserves were to double again in the next three years and if the exchange market grows 20 percent, as it did in 2007-2010, China would hold more than the daily trading volume in all currency instruments...The net flows required to move a currency pair are much smaller than the daily trading of the market...If China decided to actively trade its reserves, it could not only influence the exchange rate of the yuan---as it has done so far---but also effectively set the level, or at least a trading range for other currencies.”

In March 2009, the head of China’s central bank called the eventual creation of a new international currency to replace the dollar, a sign that the Chinese government was concerned about its huge dollar reserves. The new currency would be controlled by the IMF and ideally be more stable than the dollar. In March 2010, China’s central bank government suggested creating a new “super-sovereign currency, unattached to any single nation, for international trade.

Moving to Make the Yuan an International Currency

China's trade is increasingly conducted with emerging markets, but the transactions are invoiced neither in the yuan nor those countries' own currencies. That will change. Smaller countries have greater incentives to appease a dominant, fast-growing trading partner, and diversify some of their reserves beyond the weakening dollar or euro. [Source: Kopin Tan, Barron’s, November 14, 2011]

Beijing also is tweaking tax policies, and multinational banks eager for a piece of the cross-border yuan trade have quickly launched a global clearing system. HSBC estimates, for example, that half of China's trades with emerging markets will be settled in the yuan within three to five years, up from less than 3 percent now. Unlike Japan, Switzerland or the U.K., China has the economic heft and momentum to propel the yuan to reserve status. But first it will need to make the yuan convertible, create deep and liquid domestic bond markets, and improve the rule of law, says Markus Jaeger, a director of global risk analysis at Deutsche Bank.

Among the steps taken by China to speed up the yuan's internationalization are: 1) In July 2009, it selected five coastal cities -- Shanghai, Guangzhou, Shenzhen, Zhuhai and Dongguan -- where trade with Hong Kong, Macau or certain Southeast Asian countries could be settled using the yuan. Less than a year later, that pilot scheme was swiftly broadened to 20 cities, and their cross-border trades with all foreign partners.

2) Beijing has allowed foreign central banks, starting with Malaysia, to hold yuan reserves, and it has inked swap lines to boost bilateral trade and investments with neighbors like Singapore and Korea, and with countries as far away as Argentina, Belarus and Iceland. Following a visit by vice premier Li Keqiang to Hong Kong this summer, the Commerce Ministry has eased rules for yuan-based foreign direct investments. Beijing has also liberalized rules to allow Chinese importers to pay overseas trading partners in yuan and allow eligible exporters -- more than 67,000 at last count -- to receive payments in yuan.

3) In a controlled experiment, China has established Hong Kong as an offshore hub for trading the yuan, a market denoted by the symbol "CNH," which stands literally for "Chinese yuan deliverable in Hong Kong." Having two markets for one currency -- one offshore and one onshore -- is an artificial by-product of Beijing's need to restrict the flow of yuan in and out of the mainland, but it's a step toward letting the yuan trade freely one day. Yuan deposits in Hong Kong have jumped to nearly 600 billion in June from less than 100 billion a year ago, according to the Hong Kong Monetary Authority.

4) With such clamor, Chinese Vice Premier Wang Qishan held talks this September with U.K. officials about developing another offshore hub, this time in London. This could, crucially, pave the way for the yuan to be traded outside Asia business hours. How long before the yuan can be traded round the clock? "This is still not the same as making the yuan fully convertible," notes RBS strategist Woon Khien Chia. "But it's pretty much the very last step toward full convertibility."

5) Beijing also is aggressively establishing Hong Kong as a market for bonds denominated in offshore yuan, which has been nicknamed the "dim sum bond market." The China Development Bank issued the first such bonds in 2007, but the market took off last year after regulatory limits were eased.

The dollar most likely will remain the dominant reserve for decades. For all our fretting, America has been a debtor nation and China a creditor for years. For foreign institutions to abandon the dollar, they must believe the U.S. will default on its debt. And most Americans still believe -- or hope -- that such a disaster can be averted. The dollar's share of global forex reserves has shrunk by roughly one percentage point a year since the credit bubble burst in 2008.

China to Make Shanghai Global Yuan Hub by 2015

In January 2012, Reuters reported: China intends to establish Shanghai as the global centre for yuan trading, clearing and pricing over the next three years as part of broader plans to make the commercial hub an international financial centre by 2020. The plan for Shanghai's financial innovations through 2015, published jointly by the country's economic planning agency and the Shanghai government , set goals on a wide range of areas aimed at further developing Shanghai, though some analysts said many of them appeared ambitious. "This anticipated pace of development looks a bit quick to me," said Frances Cheung, a strategist at Credit Agricole in Hong Kong. [Source: Kazunori Takada and Samuel Shen, Reuters, January 30, 2012]

China wants to transform Shanghai into an international financial centre on par with the likes of New York and London by 2020. That goal was set in 2009 by the State Council and analysts have taken it as a broad deadline for liberalizing the currency. The state economic planning agency, the National Development and Reform Commission, outlined a series of goals under the 2015 yuan plan. These included making the daily yuan mid-point published by the central bank in the onshore yuan market serve as the benchmark for both domestic and foreign yuan trading markets.

Currency traders interpreted the statement partly as a message from Beijing that the yuan's movements, which have increasingly been influenced by the offshore market, should be decided by the government. "There have been recent developments that have put Hong Kong's offshore market in the spotlight from time to time, such as its pricing of the yuan quite differently from the onshore market," said a trader at a European bank in Shanghai"In this sense, the NDRC statement is published at a sensitive time and means the government once again wants to emphasize that it has the final say in the value of the yuan."

The plan also aims to make the government-backed Shanghai Interbank Offered Rate (Shibor) the benchmark for yuan credit everywhere and targeting to more than double the annual non-forex financial market trading volume to 1,000 trillion yuan by 2015. While the plan lacked details on how China would achieve these targets, analysts were skeptical on the feasibility of some of the planks in the platform. "Shibor is not even a very well established benchmark onshore," Cheung said. Markets currently use the government's seven-day repurchase rate as the lending benchmark.

China has taken a series of measures over the past two years to invigorate the offshore yuan market in Hong Kong as part of a longer-term plan to promote the use of the yuan overseas and make it a fully-convertible and international reserve currency along with the U.S. dollar. "Promoting Shanghai as an onshore yuan centre complements Hong Kong's growing role as an offshore yuan center, and should help to strengthen the circle of onshore-offshore yuan flows underpinning the yuan trade settlement process," said Donna H J Kwok, economist at HSBC in Hong Kong.

Yuan Replacing the Dollar?

Some have gone as far as to say that yuan will replace the dollar as the ,main global currency in the not too distant future. Qu Hingbin of HSBC in Hong Kong told Time that 40 percent to 50 percent of China’s trade could settled in yuan by 2012.

Kopin Tan wrote in Barron’s, “The U.S. dollar is the currency of the world, but that dominance could begin to erode if China has its way. It won't happen right away, but by the end of the decade, the yuan could join the buck and the euro as one of the world's reserve, or anchor, currencies. Nearly three of every four of our hundred-dollar bills circulate abroad. Oil, copper and almost every other internationally traded commodity is denominated in dollars. The vaults at foreign banks and governments are stuffed with greenbacks. Sixty percent of the planet's foreign-exchange reserves are made up of U.S. dollars, far more than 27 percent for the euro and 4 percent for the yen. [Source: Kopin Tan, Barron’s, November 14, 2011]

But with the dollar depreciating and the euro imploding, China is seizing the opportunity to encourage other countries to use its currency as a medium for trading and investments, as well as a store of value. It's a big leap forward since the yuan -- also called renminbi, which translates literally into "the people's money" -- is tightly controlled and isn't freely convertible into other currencies.

In recent years, China has stepped up an ambitious plan to increase the circulation of yuan outside the mainland and persuade trading partners to use it to invoice or settle transactions. And it is aggressively building a market for yuan-denominated debt. In the past year, McDonald's as well as Caterpillar and Unilever have all raised money by issuing yuan-denominated debt in Hong Kong. And that's just a start.

If all goes according to plan, the yuan could become one of the world's reserve currencies as soon as 2015 -- a daunting deadline, given the political and economic challenges of making the yuan freely convertible. Morel ikely, it will become an alternate reserve to the buck and the euro around 2020 -- the target China has set for Shanghai to join New York and London as a global financial hub.

This being China, everything must happen at Beijing's pace. The yuan cannot become a credible reserve until Beijing relinquishes its rigid control of the exchange rate and allows capital to flow freely in and out of the country. Yet in the short term, China can't afford for that to happen until it has successfully implemented its five-year plan to shift its export-reliant economy toward domestic consumption and services. Allowing the currency to rise too quickly would hurt the competitiveness of its still-powerful manufacturers.

But over the long haul, internationalizing the yuan plays into Beijing's grand plan. "The last three years have made it clear to China that it can't sustain a growth model that's overly dependent on U.S. or European consumers," says Stephen Roach, non-executive chairman of Morgan Stanley Asia. "This has given China a number of imperatives, one of which is to stay the course of gradual currency appreciation and internationalization."

In many ways, the yuan is a modern Chinese paradox. China has the world's second-biggest economy yet its currency remains diminutive on the global stage. Beijing would like that to change. China's official forex reserves topped US$3.2 trillion this summer. By 2015, in Deutsche Bank's estimate, China could end up with a third of all publicly held U.S. Treasuries. In fact, China's stash of foreign reserves relative to domestic money stock is more than 10 times that of the U.S. RBS estimates that the People's Bank of China can easily print 10 times more yuan without having to accumulate any more reserves to back them up.

The dollar remains the world's dominant reserve currency partly because of inertia. Our economic heft, transparent government and well-established rule of law have persuaded generations of foreigners to hold the buck as a store of value. Old habits die hard. It took decades after the U.S. economy surpassed Britain's for the buck to supplant the pound sterling as the world's "go to" money. In recent years, however, the dollar has clung to its exalted status "not so much because of its quality, but because of its liquidity," says Axel Merk, president of Merk Investments and manager of its various currency mutual funds. "One advantage of issuing so much debt is you end up with a deep, liquid market."

Image Sources: China Today, except the first one, Treehugger

Text Sources: New York Times, Washington Post, Los Angeles Times, Times of London, National Geographic, The New Yorker, Time, Newsweek, Reuters, AP, Lonely Planet Guides, Compton’s Encyclopedia and various books and other publications.

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© 2008 Jeffrey Hays

Last updated August 2012

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