I Get By With Alittle Help From My Friends....
Would you like to react to this message? Create an account in a few clicks or log in to continue.
I Get By With Alittle Help From My Friends....

Dinar Outcast


You are not connected. Please login or register

A guide to China's currency plan

Go down  Message [Page 1 of 1]

1   A guide to China's currency plan Empty A guide to China's currency plan Wed Sep 15, 2010 11:05 pm

littlekracker



Wed, Sep 15, 2010
Reuters

A guide to China's currency plan

By John Foley and Wei Gu

CHINA'S plans to make its currency global could change the world - if they get off the ground.

More international use of the yuan might increase China's trade clout, unseat the mighty US dollar and make a lot of financiers very rich in the process.

But it can be hard to separate the facts from the fable. Here are some questions answered.

Why are people talking about an international yuan?

China is the world's second-biggest economy. But its currency doesn't nearly match its size. For most international dealings, China relies on the US dollar, which leaves it beholden to the United States. Beijing wants more influence on the global stage, so it has been taking baby-steps to turn the yuan into an internationally used currency.

The pace has picked up lately. In August, Beijing decided to let foreign banks use the yuan they already hold to invest in the domestic interbank market; it allowed some trading of the yuan for Malaysian ringgit; and it let fast-food giant McDonald's issue a bond in yuan on the Hong Kong market, making it the first foreign non-bank to do so.

There is one big obstacle: capital controls. China's currency is not convertible, unlike the US dollar or euro. It can only leave the country through select official channels, so the amount of yuan outside of China is small. What you can't get, you can't use. Until that changes, a global yuan will be a pipe dream.

What is an international currency anyway?

Think of the US dollar as the template. It features in 85 per cent of foreign exchange transactions. Companies outside of the United States raise money in it; oil and other commodities are priced in it. Central banks also save US dollars: the greenback makes up almost two-thirds of global reserves.

Global currencies share three qualities. First, they are used to trade across borders. Second, they are used internationally to measure the value of goods, services or even other currencies. Finally, they are regarded as a store of value, that individuals and governments actually want to hold.

China has good reason to want entry to that club. More trade priced in yuan would reduce Chinese companies' currency risk. The government could also borrow more cheaply by issuing debt in its own currency to foreign investors. China runs surpluses today, but that is likely to change one day.

A more pressing goal is to make sure trade partners can still buy Chinese goods even if they can't get US dollars. That previously unthinkable scenario came to pass during the financial crisis, when banks hoarded the greenback, creating a major hiccup for exporters. Since then, the US dollar no longer looks so dependable.

What has happened so far?

Most changes so far have focused on trade. Last year, China started letting exporters and importers in a handful of places settle cross-border trade in yuan. It recently broadened that to 20 Chinese provinces and all of China's trade partners. These flows of yuan mostly replace existing trades in US dollars, yen or euro, so don't really breach the capital controls.

But trade only goes so far. Few foreigners have yuan available to buy Chinese goods, and not everyone wants to accept them in return for selling to China. Hang Seng Bank expects yuan-settled transactions to more than double to 100 billion yuan (US$15 billion, S$19.8 billion) by the end of this year, but that would still be a tiny part of China's US$2 trillion yearly trade.

So China is now moving on to investment, to make the yuan an asset that people want to hold. Previously, there was no official way for foreigners to lend in Chinese currency, so it was hard to get much of a return. The launch of yuan-denominated bonds in Hong Kong changes that. Some foreign banks will now be allowed to lend their yuan to Chinese lenders on the interbank market, too. These are important steps: before, the only reason to hold yuan was the hope that the currency might increase in value.

But once again, the same old problem: foreign investors can only use what they can get their hands on. Demand for yuan bonds in Hong Kong, for example, is limited to the amount of Chinese currency sitting in local bank accounts. More investment opportunities may attract more funds, but currently yuan deposits total just US$15.3 billion.


So will China have to dismantle its capital dam?

The dam is already leaking a bit. Hong Kong residents can now buy 20,000 yuan each day, and more comes with tourism from the mainland. But that isn't enough to build up global traction. China has also signed some currency swaps with other countries - US$118 billion so far - but these are supposed to be used for trade, and remain largely remain unused. The dam either has to come down - or at least spring a lot more leaks.

Dismantling it, though, is complicated. The main obstacle is China's currency, which is effectively pegged to the US dollar. Beijing sees its dollar peg as an important tool for maintaining stability. The central bank pledged to reform it three months ago, but the yuan has still hardly budged.

While the yuan's value remains tightly controlled, most capital controls are likely to stay in place. It is, after all, very hard to fix a currency if capital is free to slosh around without any barriers. The risk is that hot money floods in when times are good, magnifying bubbles, and then drains away when times are bad, accentuating busts. What's more, countries with fixed currencies and free capital tend to lose control of their monetary policy.

That leaves Beijing in a bind. Getting the yuan into foreign circulation means loosening the capital controls, but that probably means further reform of the currency peg. So, just as it did with other kinds of reform, China is moving slowly, seeing how far it can get without upsetting the status quo.

What is likely to happen next?

Even without breaking the dam, China can do more. It is likely to start by offering more investment opportunities for the yuan that do find their way out - either legitimately or not.

Beijing may, for example, expand foreigners' access to mainland stock markets beyond the few big stocks also listed in Hong Kong, which are often more expensive than their Shanghai-traded equivalents.

Large foreign institutions can already buy shares in mainland firms through a US$30 billion qualified foreign institutional investor (QFII) programme - but they must invest first in US dollars, which are then converted into yuan. A new plan known as the 'mini-QFII' extends that to Hong Kong brokerages, and lets them invest in yuan directly.

Another idea is for mainland companies to issue yuan-denominated shares in Hong Kong. More companies on both sides of the border will almost certainly issue yuan-denominated bonds in Hong Kong - as Russian miner Rusal is about to do. A currency forwards market may follow; currently there are only 'non-deliverable' forwards, where no yuan changes hands.

But it won't be quick. China has set a 2020 goal to develop Shanghai as a global financial centre commensurate with the status of the yuan, and China's role in the world markets. So 2020 is seen as a tentative deadline for yuan internationalisation.

So is this the end of the dollar?

Hardly. China probably covets the US dollar's pre-eminence, and should overtake its biggest trade partner in size as soon as 2025, by Deutsche Bank estimates. Yet even once the yuan becomes international, unseating the US dollar could take decades. A global currency of choice must be very liquid, and fully convertible.

A global currency also needs to have investors' trust. The US dollar, sterling, the euro and the yen are backed by countries with relative economic stability, sustained low inflation and transparent institutions. China, despite much progress, lacks all three.

Finally, being the 'new dollar' would come with strings. Since the greenback makes up 62 per cent of global reserves, most countries have a vested interest in how the US runs its economy. Everyone - especially China - is a critic. It is hard to imagine the People's Republic welcoming such scrutiny.

Back to top  Message [Page 1 of 1]

Permissions in this forum:
You cannot reply to topics in this forum