The Chinese yuan will become a convertible currency and be released globally for trade by 2020, when China’s economy will be the largest in the world, according to Beijing. Will the PRC’s currency be able to enter a troika of the major global currencies and won’t this attempt bring about a new financial war?
The non-convertible yuan automatically associated itself with the world’s financial elite. One advantage of China’s currency was that it was hard to organize any kind of attack against it. There are few yuan in the markets, and consequently it is hard to buy in any meaningful quantity. The yuan is therefore invulnerable to Washington and China can prop up the exchange rate so as not raise the cost of its exports to the U.S.
But China already has big plans for its currency: The yuan will become a global reserve currency by 2020, when, Standard Chartered forecasts, its economy will overtake the U.S. economy to become the largest in the world. So far, the IMF is looking askance at this idea: The Fund doesn’t intend to include the yuan in the Special Drawing Rights (SDR) currency basket, since its non-convertibility in current transactions makes it impossible to recognize it as one of the global currencies.
A Strategy Well Thought-Out Long Ago
China is doing everything it can to further the yuan’s increased usage in international transactions, and is doing so seemingly based only on economic considerations. However, there is increasing evidence that this strategy to gradually transform the yuan into a global reserve currency was approved back at the end of the 1990s under General Secretary Jiang Zemin, and has already been long underway.
Li Jing, a representative from the Center for International Finance in the Chinese Academy of Social Sciences, describes such a strategy, which consists of four stages. The first stage is managing payments in yuan with neighboring countries. In the second stage, they plan to turn the yuan into a means of payment that can be used worldwide in trade settlements with China. In the third stage, the yuan will become an attractive tool for investing funds from households, enterprises, and financial institutions (currently done in dollars and euros). Finally, in the fourth stage, the yuan becomes a global reserve currency, which the central banks of other countries will be eager to buy.
The first step began in the early 2000s, when Beijing began negotiating with its neighbors about the possibility of trade settlements in national currencies. For companies that import from China, this reduces the costs of conversion and exchange-rate insurance.
Before the global crisis and right after it, such activity in Beijing grew dramatically. Since winter 2008, Beijing began doing currency swaps with neighboring countries, selling yuan to South Korea, Hong Kong, Malaysia, and Belarus. And in spring 2009, Chinese financial authorities went public with their plan and allowed settlements to be done with yuan in international trade.
According to forecasts by HSBC, by the end of 2012, the volume of trade settlements completed in yuan totaled $2 trillion, or approximately half of China’s foreign trade. This scheme could be opened up even more with the beginning of trading yuan against the major global currencies. On the China Foreign Exchange Trade System (CFETS), the yuan is already trading against the U.S. dollar, the euro, the British pound, the yen, the Hong Kong dollar, and the Malaysian ringgit. In July, trade between the ruble and the yuan began.
“China could carry out all or almost all of the steps towards [the yuan entering on a global level] within several years,” Guan Tao, the head of the Chinese State Administration of Foreign Exchange, told our correspondent. “Over the next few years, China could announce the full convertibility of the yuan.” According to the official, reforms are happening in two stages. First there will be a radical weakening of foreign exchange restrictions from the Central Bank, followed by a planned transition to a convertible currency for balancing the capital account. Liberalizing currency control will allow businesses, investors, and individuals to trade the yuan outside China’s borders without any significant barriers, says Tao.
At the same time, both Chinese and foreign analysts warn of the dangers of such a step: If these changes happen too quickly, the entire Chinese financial system could be threatened. “Premature liberalization is fraught with risk and could lead to a crisis; therefore, China should continue to adhere to the precautionary approach,” notes Deputy Director of IMF Asia Marcus Rodler.
Nobel Prize winner in economics Robert Mundell, who is often referred to as the “father of the euro,” believes that China’s plans will become a reality: “If we consider the possibility of a third global currency in addition to the euro and dollar, it would of course be the yuan. In ten years, the growth of China’s GDP could well reach that of the U.S. Even now, it has reached half of the U.S. GDP and is constantly increasing. That’s why by sometime around 2025, China’s GDP will catch up to America, and it’s quite possible that the world will have three global currencies – the dollar, the euro, and the yuan.” But he also doesn’t deny that the Japanese yen could become a fourth global currency. “But the Chinese and Japanese currencies have fairly large competition, and if the dollar and euro calmly interact with one another, then the yuan and yen don’t,” Mundell told World Economic Journal.
Mundell doesn’t view as realistic the creation of a single currency on the Asian continent, as occurred in Europe. “Unifying currencies is a very serious political step, hardly suitable for the present. Asian countries will be able to calmly interact with their own currencies and simply regulate exchange rates.”
Text: Valeriya Khamrayeva