yuan special report

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SEPTEMBER 2010

THE YUAN CHARGE

The Obama administration and

U.S. politicians are taking China

head on over the yuan. As

Congress comes closer to

punishing Beijing for not letting

the currency strengthen more

rapidly, Reuters explains the

factors behind the yuan’s sudden

gains, the U.S. legislation being

considered and the factors

driving China’s policy.

Q+A

• W S T UA RS ASTR A O A SU?

• W WASTO W TOOS TO RSSUR CA?

FACTBOX

• K ROSOS O T U.S. OUS CURRC B

ECONOMIC SIGNALS

• CA OCKS SCUATORS OUT O UA AS

BREAKINGVIEWS

• U.S. UA RA A ASCAT BUT AW

• CA’S UA A: A U OR T R



THE YUAN CHARGE SEPTEMBER 2010

2

Q+A

W S T UA RS ASTRA O A SU?By AlAnWheAtley And SimonRABinovitch

BEIJING, Sept 21

CIN’S yuan has quickened its rate oclimb against a backdrop o growing U.S.criticism o China’s exchange rate policy.

The People’s Bank o China, which tightly man-ages the currency, let the yuan rise on Tuesdayas high as 6.6987 per dollar – above 6.70 or thefrst time since Beijing unshackled the currencyrom a decade-old peg to the dollar in 2005.

Following are the answers to some questionsraised by the recent rise in the yuan, also calledthe renminbi.

WY IS CIN LETTING TE YUN RISEMORE QUICKLY?

The best guess – and when it comes to policymoves in China, it can be only a guess – is thatBeijing is responding to both economic unda-mentals and political considerations.

In a series o fve articles in July setting out thePBOC’s thinking about the yuan, deputy centralbank governor u Xiaolian emphasised the im-portance o the trade surplus as a determinanto the exchange rate.

The surplus has averaged $22 billion a monthsince May, strengthening the hand o the PBOCand other advocates o aster appreciation intheir internal debates with opponents led by thecommerce ministry.

SURELY EXTERNL POLITICS RE DECISIVE INFLUENCE?

Beijing insists that the yuan is a sovereign issuethat it alone will decide.

“But in reality it has been making some conces-sions. It takes very seriously the pressure romthe United States over the renminbi exchangerate,” said Sun Zhe, a proessor at TsinghuaUniversity in Beijing who specialises in China-U.S. relations.

Sun said Congress was unlikely to pass legisla-tion punishing China or holding down the yuanbeore a visit by President u Jintao, whichdiplomats say is pencilled in or January.

But U.S. pressure could nonetheless orce Chi-nese policymakers to think more seriously aboutwhether a stronger yuan was in the country’ssel-interest, the proessor said.

Xu Biao, an economist with China Merchants

Bank in Shenzhen, said the yuan might risemore strongly than expected in light o criticismon Monday rom President Barack Obama.

“The resh comments rom Obama are likely toput unprecedented pressure on the yuan to riseas Japan and Europe may ollow Washington,”Xu said.

Sun said it was important to bear in mind thatChina is also eeling the heat rom developingeconomies such as Brazil and India. “This pres-

sure is coming rom many countries and Chinahas to respond beore the G20 summit,” he said.

The next G20 summit is in Seoul on Nov. 11-12.It was no coincidence that China announced anend to the yuan’s 23-month-old de acto peg

Yuan NDFs try to keep up with mid-point fixings

Source: Thomson Reuters

Reuters graphic/Christine Chan

2 2 / 0 9 / 1 0

12-month yuan NDF 3-month yuan NDF Dollar/yuan mid-point fixings

6.5

6.6

6.7

6.8

6.9

7.0

SAJJMAMFJan 2010




3

to the dollar on June 19, just a week beore theprevious G20 summit in Toronto, where it earnedplaudits or its move.

IS TIS TIME DIFFERENT?

The yuan’s appreciation versus the dollar hasbeen unquestionably ast over the past 9 days,prompting traders to describe it as a mini-revaluation. It is the longest string o gains sincea landmark revaluation in July 2005, whenthe yuan’s 11-year ormal peg to the dollar wasbroken.

But it is not entirely without precedent. Chinalet the yuan rise at about the same pace inearly 2008, when it was trying to tame soaring

ination. China could push the yuan up to 6.6against the dollar in coming weeks, traders say,which would mark a nearly 3 percent rise sinceearly September, reecting the intensity oU.S. pressure.

The risk or China is that it will invite unwantedhot-money inows i it makes a habit o allow-ing the yuan to appreciate ahead o importantpolitical dates.

key question, then, is whether the PBOCmakes good on its promise to introduce morevolatility into the exchange rate so that specula-tors do not view the yuan as a one-way bet. Itwould not be surprising to see the currency allback at least somewhat against the dollar aterthis burst o appreciation.

OW MUC S TE YUNCTULLY GINED?

When the PBOC said three months ago that itwould increase exchange rate exibility, manyobservers believed that it would fnally ulfll its

pledge to manage the yuan against a basketo currencies.

On that count, the yuan’s gains over the pasttwo weeks seem ar less impressive. In July andugust, while inching up against the dollar, theyuan actually ell 2.8 percent against a trade-weighted basket o currencies, according tocalculations by the Bank or InternationalSettlements.

The yuan’s perormance against the euro has

been even more dismal. The Chinese currency isdown 3.6 percent against the euro since its Junede-pegging. Even during the yuan’s mini-revalu-ation against the dollar, it has continued to all

versus the euro, because the euro itsel has been

even stronger against the U.S. currency.

owever Beijing manages the yuan, one thing is

certain: it will not appreciate against the dollar

or at least eight o the next 12 trading days.

Chinese markets are closed or Mid-utumn

Festival and National Day holidays, giving the

yuan – and policymakers – a breather.

WT ELSE IS CIN DOING?

Politically, the yuan’s nominal exchange rate is

an easy target or critics to latch on to.

Economically, what determines competitive-

ness is the real, or ination-adjusted, eective

exchange rate against a basket o currencies o a

country’s trading partners.

The yuan’s real eective exchange rate has risen

19 percent since 2005; its nominal eective

exchange rate is up 14 percent over the same

period.

China is gently engineering a degree o real ap-

preciation by increasing the cost o manuactur-

ing in China.

ter a pause during the global fnancial crisis,

wages are again rising at an annual pace o

about 15 percent to 20 percent.

Rebates on exports o dozens o commodities

have been scrapped. nd on-grid power taris

are expected to rise next month

(dditional reporting by Chris Buckley and Zhou

Xin; Editing by Ken Wills)

A resident looks at a bro-

chure of yuan banknotes at

a branch of People’s Bank of

China, the central bank, in

Shenyang, Liaoning province

September 23, 2010.

REUTERS/Sheng Li




4

Q+A

W WASTO WTOOS TO RSSUR CA?Sept 22

TOP Obama administration ofcials havestepped up criticism o China’s tightcontrol over its currency’s value and have

signaled a readiness to work with U.S. lawmak-

ers crating legislation to orce the yuan to ap-preciate more.

The drive or legislation is accelerating. TheU.S. ouse o Representatives Ways and MeansCommittee plans to vote on a China currency billon Friday and the ull ouse is likely to vote nextweek.

China dropped a 23-month-old dollar peg onJune 19 and since then the yuan has risen about1.8 percent, with most o that rise occurring in

the last nine trading days.

That has not been enough to appease U.S. o-fcials who see trade defcits with China topping$200 billion annually.

It also has not calmed congressional Demo-crats who are likely to see their ranks thinnedin November elections by voters worried aboutstunted job prospects oten blamed on a ood ounairly cheap Chinese imports.

Following are answers to some questions arisingrom recent testimony and comments by ofcialsin Washington and overseas.

ISN’T TIS JUST MORE NGRY POSTURING?

There is anger but U.S. Treasury Secretary Timo-thy Geithner came close last week to endorsinga ouse bill that could slap duties rom coun-tries with “misaligned currencies” – terminologyclearly aimed at China.

“We are careully looking at it,” he told Congress

during a ull day o hearings beore the ouseand Senate.

Geithner said any bill must meet World TradeOrganization rules, words that were seen by

analysts as a shit rom the usual stance o try-ing to talk legislators into backing o and allow-ing diplomacy time to work.

Representative Sander Levin said the bill hispanel will consider on Friday will meet that test.

President Barack Obama is to meet Chinese Pre-mier Wen Jiabao on Thursday on the sidelineso an annual U.N. meeting in New York, possiblytaking his criticisms o the yuan’s slow progressright to the top o an extensive bilateral agenda.

WY NOT USE EXISTING LEGL REMEDIES?

Geithner expressed some exasperation at thelimits o the existing congressionally mandatedsemiannual review that requires Treasury to as-sess currency practices o key trade partners anddecide whether they manipulate their currenciesor trade advantage.

Public interest is almost totally ocused onwhether Treasury calls China a manipulator,something that the Obama administration hasreused to do in the three reports it has issuedsince taking ofce.

U.S./China trade

Sources: CIA World Factbook, U.S. Census Bureau, U.S . Bureau of Economic Analysis*Growth rate for 2010 Q2. **Till July 2010.

Reuters graphic/Christine Chan 22/09/10

Imports

CHINA

Population 1.33 bln

GDP, 2009 est $4.9 trillion

GDP growth* 10.3%

Population

18.1%

6.8%

307.21 mln

GDP, 2009 est $14.3 trillion

GDP growth* 1.6%

U.S.

0

50

100

150

200

250

300

350

U.S. trade deficit with China – $ bln

China’s share of U.S. global trade – %

Exports

Imports Exports

0

5

10

15

20

'04 '05 '06 '07 '08 ' 09 '10**'09'08'07'06'05'04'03'02'01

Trade deficit



5


Geithner noted that, even i the brand was ap-plied, all it does is compel Treasury to initiatetalks with Beijing, which he noted it already isdoing. But he pointedly said that yuan apprecia-tion was “too slow” and said that will be takeninto account as a scheduled Oct. 15 report ap-proaches.

“We are examining what mix o tools, thoseavailable to the United States as well as mul-tilateral approaches, might help the Chineseauthorities to move more quickly,” he added.

ISN’T TIS BETTER DELT WIT IN GLOBLCOUNCILS LIKE TE G20?

In one way, yes, because China’s burgeoningtrade surpluses, which have been averaging

$22 billion a month since May, reect a globalproblem. The other side o the equation is swell-

ing defcits or the rest o the world.

“In the G20, we expect China’s commitment to

rebalancing to be a key part o the agenda at the

leaders’ Summit in Seoul later this year,” Geithn-

er said in a reerence to the Nov. 11-12 meeting.

“ more exible renminbi (yuan) is in the best

interests o the entire global community.”

But there are reasons why working through theG20 may not work well. China is a member and

might be able to block any such eort and the

United States won’t fnd it easy to muster sup-

port or a coordinated bid to orce Beijing to let

to yuan appreciate more rapidly.

bln

China exports to U.S.U.S. exports to China

$69.5 bln $296.4 bln

China-U.S. Total Trade, 2008-2009

2010 2020 2050 2010 2020 2050

CHINA UNITED STATES

0.0

0.5

1.0

1.5

2.0

Total population projections

1.35bln

1.43bln

1.47bln

307.2mln

335.8mln

419.9mln

CHINA, 2010 est. (Median age 35.2) 0-14 yrs. 15-64 yrs. 65+ yrs.

20.2% 67% 12.8%

U.S, 2009 est. (Median age 36.8) 0-14 yrs. 15-64 yrs. 65+ yrs.

19.8% 72.1% 8.1%

Age breakdown

Labour force(2009 est.)

Urbanisation Literacy

China43%

U.S.82%

China91.6%

U.S.99%

U.S.

154.2 mln

813.5 mlnChina

U.S.CHINAGDP 2009 GDP growth rates (estimates)

$4.9 trillion

$14.3 trillion

0

-5

5

10

%15

2007 2008 2009

1.9%

13%

0%

9%

-2.6%

9.1%

Sources: IMF, CIA World Factbook, government data, Reuters

Total trade

in 2009: Imports$1.95 trlnExports$1.57 trln

Imports $954.3 blnExports $1.201 trln

U.S. CHINA

POPULATION TRADE

WORLD’S BIGGEST ECONOMIES Comparing China and the U.S.

ECONOMY

FRICTION POINTS

Economic ties and currency

China and the United States are economicallyintertwined, but China's huge trade surplus haslong frustrated Washington

China is projected to surpass the U.S. as the world's largesteconomy in 2025, according to financial institutions such asthe World Bank. Preliminary statistics show China overtookJapan as the world's second biggest economy this year

Trade and investment

The two countries have clashed over trade policies,investment rules, and the Chinese regulatoryenvironment, especially control of the Internet

The U.S. deficit with China was $226.9 billion in 2009and is on track to total $249 billion for 2010, accordingto the U.S. government

Chinese territorial issuesBeijing has never renounced the use of force to reclaimself-ruled island Taiwan, which it considers its territory

The Tibetan issue

Exiled Tibetan spiritual leader the Dalai Lama metU.S. President Barack Obama in February, drawingmore official denunciations from Beijing whichreviles the Dalai Lama as a "separatist"

The United States says it wants the two sides tosettle the dispute peacefully and is obliged byU.S. law to help the island defend itself




6

Chinese Premier Wen Jiabao

speaks during a dinner

hosted by the National

Committee on U.S.-China

Relations and the U.S.-

China Business Council at

the Waldorf Astoria in New York September 22, 2010.

REUTERS/Keith Bedford

Click for a

Sept. 17 PDF

on yuan trading

strategies,

analyses,

commentary

and charts

euro zone monetary ofcial told Reuters thatcountries like Germany, or example, don’t shareWashington’s urgency about yuan revaluationbecause their trade situation is not so unbal-anced.

“It’s largely a bilateral (U.S.-China) matter withthe rest looking on as spectators, either becausethey don’t count or because they aren’t veryinterested,” the ofcial said.

Others, like Brazil, reserve the right to interveneon their own currencies’ behal i necessary andso have less inclination to criticize Beijing.

“I believe that this idea o putting pressure ona country is not the right way or fnding solu-tions,” Brazilian Foreign Minister Celso morimtold Reuters on Tuesday.

WOULD FSTER YUN REVLUTION SOLVEPROBLEMS WIT U.S. TRDE DEFICITS NDJOB LOSSES?

It might not solve them but it should slow thedeterioration in bilateral trade balances, whichis part o the broader issue o global imbalances.

China’s oreign ministry, though, singled out ay-in-the-ointment on the touchy question ojobs, however, by noting that there plenty o

other countries ready to oer cheap labor.

“The trade imbalance between China and theU.S. is not decided by exchange rate, but by glo-balization. Yuan appreciation cannot solve theU.S. trade defcit, on which the mericans have

already reached consensus,” China’s oreignministry said in a statement on Tuesday.

Many job losses stem rom U.S.-based compa-nies shiting basic assembly jobs and inorma-tion-processing tasks to countries like China,Vietnam or India, seeking to push profts up bytaking advantage o lower labor costs.

WT OTER OPTIONS RE OPEN TOTE U.S.?

The United States has launched multiple caseson individual trade issues against China in theWorld Trade Organization, including two lastweek. They don’t relate directly to currency butit’s an undertone and that could be sharpenedby taking a harder line with Beijing.

t the Reuters Washington Summit on Wednes-day, U.S. Trade Representative Ron Kirk saidcountries need to “behave the way they said theywould” in markets.

“We want government to get its thumb o thescales. We want state-owned enterprises to getout o the business and just let us compete,” hesaid.

Though he reerred to a specifc product market,U.S. exporters say their participation in many

Chinese markets suers because o hurdlesranging rom entry requirements to currencydisadvantages.

(Reporting by Glenn Somerville; Editing byStacey Joyce)

http://r.reuters.com/cad44p











7

WSINGTON, Sept 22

TE ouse o Representatives Ways andMeans Committee will vote on Friday ona bill lawmakers say will give the Obama

administration a new tool to protect U.S. com-

panies and workers against China’s currencypractices.

ere are key provisions o the bill and a descrip-tion o how it diers rom an earlier proposal:

WT TE BILL DOES

The legislation essentially clears the way or theCommerce Department to apply countervail-ing duties against imports rom countries with“undamentally undervalued” currencies.

The bill’s key element instructs the CommerceDepartment that it may no longer dismiss a re-quest or countervailing (or anti-subsidy) dutiesbased on the single act that exporters are notthe sole benefciaries o a particular subsidy.

In other words, just because Chinese domesticmanuacturers may also beneft rom currencyundervaluation, the Commerce Departmentcould still consider it an export subsidy.

This reverses a long-standing Commerce De-partment practice, most recently seen in twocases involving coated paper and aluminumproducts.

The department declined to investigate whetherundervaluation was a subsidy because it saidChina’s exchange rate practices did not providea “specifc” beneft to Chinese exporters.

Ways and Means Committee aides say that ismore restrictive than required under U.S. lawand World Trade Organization rules.

They note the bill does not guarantee theCommerce Department will apply countervail-ing duties against undervalued currencies, butremoves an important hurdle.

OW FUNDMENTLLY UNDERVLUED

CURRENCIES RE DEFINED

currency is said to be undamentally underval-

ued i the ollowing criteria are met:

1. The country’s government has engaged in

protracted, large-scale currency intervention in

at least one oreign exchange market during an

18-month period.

2. The country’s “real eective exchange rate”

is undervalued by at least 5 percent over the

18-month period.

3. The country has had signifcant and persistentglobal current account surpluses during the 18

months.

4. The amount o oreign reserve assets held by

the government during the 18 months exceeds

the amount necessary to repay its debt obliga-

tions within the next 12 months, exceeds 20 per-

cent o the country’s money supply and exceeds

the value o the country’s imports during the

previous our months.

OW TE MOUNT OF UNDERVLUTION

IS CLCULTED

The bill instructs the Commerce Department to

rely upon approaches described in guidelines o

the International Monetary Fund’s Consultative

Group on Exchange Rate Issues to calculate the

amount a currency is undervalued.

Where appropriate, the department should use

a simple average o those approaches.

I those guidelines are not available, the depart-

ment should use generally accepted economic

and econometric techniques and methodologies.

FACTBOX

K ROSOS O T U.S.OUS CURRC B

Click for full text

of the bill

http://r.reuters.com/far94p






8

A tourist gazes up towards

the dome of the U.S. Capitol

in Washington January 25,

2010. On Wednesday, U.S.

President Barack Obama will

deliver his rst State of the

Union speech in the House

Chamber of the Capitol.

REUTERS/Kevin Lamarque

Commerce should also rely on publicly availabledata compiled by the IMF or, i not availablerom the IMF, rom other international organiza-tions or national governments.

Commerce should also look at ination-adjust-ed, trade-weighted exchange rates when calcu-lating currency undervaluation, the bill said.

REPORTING PROVISION

The bill requires the U.S. Comptroller General toissue a report within nine months on its imple-mentation.

OW TE BILL IS DIFFERENT FROMERLIER VERSION

n earlier version o the “Currency Reorm orFair Trade ct” ran 17 pages.

The new version runs six pages and no longerauthorizes the use o anti-dumping dutiesagainst undervalued currencies.

Ways and Means Committee aides say it hasbeen amended to make sure it is consistent withWTO rules.

The amended bill does not “deem” that a fnd-ing o undamental currency undervaluationsatisfes the requirement o export contingency,as the original bill did.

(Reporting by Doug Palmer; Editing by Stacey Joyce)




ECONOMIC SIGNALS

CA OCKS SCUATORSOUT O UA AS

9

By SimonRABinovitch

BEIJING, Sept 23

ONE o China’s big ears about resumingyuan appreciation is that it serves asa magnet or hot money inows. Who

could pass up a one-way bet on a stronger cur-rency?

But as this chart shows, Beijing has outankedspeculators, or now at least.

The orange line measures illicit money inows (itis obtained by subtracting trade and investmentreceipts rom the total amount o yuan issueddomestically to purchase oreign exchange).

It dropped into negative territory in May, Juneand July, indicating speculative capital actuallylet China.

n uptick in ugust, according to data releasedthis week, suggests just a handul o investorswere positioned or the yuan’s aster apprecia-tion o the past two weeks, when it rose 1.5percent versus the dollar.

Now that investors have seen the yuan’s rally,expect the orange line to rise steeply.

But this chart is also powerul evidence o why

the yuan is unlikely to rise without interrup-tion, as it did rom mid-2005 to mid-2008. otmoney inows built to a crescendo by the endo that period, giving Beijing a serious liquidityheadache.

Whatever China’s political calculations as U.S.pressure intensifes, a resumption o majorspeculative inows would be sure to act as abreak on yuan appreciation.

In act, it would not be surprising i the yuan ell

back a touch against the dollar ater anotherew weeks o gains. The central bank has vowed

to introduce two-way volatility to the exchangerate, precisely in order to wrongoot speculators.

The light blue line is a measure o total net capi-tal inows into China.

Despite a rebound in the country’s trade surplussince May, net monthly inows have averaged185 billion yuan ($27.6 billion) a month, con-siderably less than in the two years beore the

global fnancial crisis struck.

lthough some U.S. critics believe the yuan isundervalued by as much as 40 percent, Chineseofcials have been adamant that the currency isnearer to its equilibrium level.

So long as net capital inows – a proxy or mar-ket demand – remain relatively weak, Chineseofcials will have a point and large-scale appre-ciation will be o the table.

(Graphic by Catherine Trevethan; Editing by NeilFullick)




10

ByWei Gu

ONG KONG, Sept 21

TOP think tank has advised Washingtonto declare a currency war on China. Theproposal rom the Peterson Institute to

orce up the value o the yuan sounds ascinat-ing, but a direct attack may be hard to pull oin practice. Beijing is likely to respond better tomulti-lateral persuasion.

Peterson has called or a U.S. raid on the or-wards market or the yuan, which it believes hasto rise at least 25 percent against the dollar.The timing is good. U.S. lawmakers are alreadythreatening to slap taris on Chinese imports,and the 1.5 percent rise o the yuan in the pasttwo weeks hardly looks enough.

Targeting China’s currency directly goes tothe heart o the problem, whereas duties onlyaddress exports rom China on a product byproduct basis. Foreign traders can’t buy yuan inlarge quantities because o China’s strict capitalcontrols, so the next best thing is “non-delivera-ble” orwards.

These orwards, where no yuan actually changehands, don’t directly impact the exchange rate.But a big rise in their value could give China aheadache. I orwards seemed to price in strongappreciation, it could attract speculative inowsand make China’s asset bubbles worse.

While this idea is ascinating, the executionwould be tricky. The size o the orwards marketis just $1 billion on a volatile day. The UnitedStates could not intervene in such a small mar-ket without being noticed. That would risk invit-ing counter-trades by arbitrageurs, who mightsell orwards even as the United States buys.

Beijing might also inict losses on would-be

raiders. I it resolutely fxed the yuan below theorward price, the trader would make a loss.Washington may thus struggle to fnd inves-

BREAKINGVIEWS

U.S. UA RA A ASCATBUT AW

tors willing to do its bidding. Unlike Beijing, it

doesn’t control its fnancial institutions, so can’t

tell them to carry out unrewarding trades.

The biggest problem with Peterson’s idea,

though, is that Washington can’t really justiy

manipulating the yuan when it is blaming Bei-

jing or the same thing. Two wrongs don’t make

a right. Transparent, multi-lateral pressure looks

a better way to call or change.

– The author is a Reuters Breakingviews col-umnist. The opinions expressed are her own

(Editing by John Foley and David Evans)

Yuan banknotes are seen in

this illustrative photograph

taken in Beijing September

19, 2010.

REUTERS/Petar Kujundzic




11

By John Foley AndWei Gu

ONG KONG, Sept 10

C

IN’S plans to make its currency globalcould change the world – i they get othe ground. More international use o the

yuan might increase China’s trade clout, unseatthe mighty U.S. dollar and make a lot o fnan-ciers very rich in the process. But it can be hardto separate the acts rom the able. ere aresome questions answered.

WY RE PEOPLE TLKING BOUT NINTERNTIONL YUN?

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 dollar, which leaves it beholden to theUnited States. Beijing wants more inuence onthe global stage, so it has been taking baby-steps to turn the yuan into an internationallyused currency.

The pace has picked up lately. In ugust, Bei-jing decided to let oreign banks use yuan theyalready hold to invest in the domestic interbankmarket; it allowed some trading o yuan or Ma-laysian ringgit; and it let ast-ood giant McDon-ald’s issue a bond in yuan on the ong Kong mar-ket, making it the frst oreign non-bank to do so.

There is one big obstacle: capital controls.China’s currency is not convertible, unlike thedollar or euro. It can only leave the countrythrough select ofcial channels, so the amounto yuan outside o China is small. What you can’tget, you can’t use. Until that changes, a globalyuan will be a pipe dream.

WT IS N INTERNTIONLCURRENCY NYWY?

Think o the U.S. dollar as the template. It ea-

tures in 85 percent o oreign-exchange transac-tions. Companies outside o the United Statesraise money in it; oil and other commodities arepriced in it. Central banks also save dollars: the

BREAKINGVIEWS

CA’S UA A: A UOR T R

greenback makes up almost two-thirds o globalreserves. Global currencies share three qualities. First,they are used to trade across borders. Second,they are used internationally to measure thevalue o goods, services or even other currencies.

Finally, they are regarded as a store o value,that individuals and governments actually wantto hold.

China has good reason to want entry to thatclub. More trade priced in yuan would reduceChinese companies’ currency risk. The govern-ment could also borrow more cheaply by issuingdebt in its own currency to oreign investors.China runs surpluses today, but that is likely tochange one day.

more pressing goal is to make sure tradepartners can still buy Chinese goods even i theycan’t get U.S. dollars. That previously unthink-able scenario came to pass during the fnancial

People walk past a money

exchange in Hong Kong

displaying photos of yuan (R)

and U.S. dollar banknotes

September 13, 2010.

REUTERS/Bobby Yip




12

crisis, when banks hoarded the greenback, cre-ating a major hiccup or exporters. Since then,the dollar no longer looks so dependable.

WT S PPENED SO FR?

Most changes so ar have ocused on trade.In 2009 China started letting exporters andimporters in a handul o places settle cross-border trade in yuan. It recently broadened thatto 20 Chinese provinces and all o China’s tradepartners. These ows o yuan mostly replaceexisting trades in dollars, yen or euro, so don’treally breach the capital controls.

But trade only goes so ar. Few oreigners haveyuan available to buy Chinese goods, and not

everyone wants to accept them in return orselling to China. ang Seng Bank expects yuan-settled transactions to more than double to 100billion yuan ($15 billion) by the end o 2010, butthat would still be a tiny part o China’s $2 tril-lion yearly trade.

So China is now moving on to investment, tomake the yuan an asset people want to hold.Previously, there was no ofcial way or oreign-ers to lend in Chinese currency, so it was hardto get much o a return. The launch o yuan-denominated bonds in ong Kong changes that.

Some oreign banks will now be allowed to lendtheir yuan to Chinese lenders on the interbankmarket, too. These are important steps: beore,the only reason to hold yuan was the hope thatthe currency might increase in value.

But once again, the same old problem: oreigninvestors can only use what they can get theirhands on. Demand or yuan bonds in ongKong, or example, is limited to the amount oChinese currency sitting in local bank accounts.More investment opportunities may attract more

unds, but currently yuan deposits total just$15.3 billion.

SO WILL CIN VE TO DISMNTLEITS CPITL DM?

The dam is already leaking a bit. ong Kongresidents can now buy 20,000 yuan each day,and more comes with tourism rom the main-land. But that isn’t enough to build up globaltraction. China has also signed some currencyswaps with other countries – $118 billion so ar –but these are supposed to be used or trade, andremain largely unused. The dam either has tocome down – or at least spring a lot more leaks.

Dismantling it, though, is complicated. Themain obstacle is China’s currency, which is e-

ectively pegged to the U.S. dollar. Beijing seesits dollar peg as an important tool or maintain-ing stability. The central bank pledged to reormit three months ago, but the yuan has still hardlybudged.

While the yuan’s value remains tightly control-led, most capital controls are likely to stay inplace. It is, ater all, very hard to fx a currency icapital is ree to slosh around without any bar-riers. The risk is that hot money oods in when

times are good, magniying bubbles, and thendrains away when times are bad, accentuatingbusts. What’s more, countries with fxed curren-cies and ree capital tend to lose control o theirmonetary policy.

That leaves Beijing in a bind. Getting yuan intooreign circulation means loosening the capitalcontrols, but that probably means urther reormo the currency peg. So, just as it did with otherkinds o reorm, China is moving slowly, seeinghow ar it can get without upsetting the status

quo.

WT IS LIKELY TO PPEN NEXT?

Even without breaking the dam, China can domore. It is likely to start by oering more invest-ment opportunities or yuan that do fnd theirway out – either legitimately or not.

Beijing may, or example, expand oreigners’access to mainland stock markets beyond theew big stocks also listed in ong Kong, whichare oten more expensive than their Shanghai-traded equivalents.

Large oreign institutions can already buy sharesin mainland frms through a $30 billion qualifedoreign institutional investor (QFII) programme

An employee counts U.S.

dollars next to yuan

banknotes at a bank

in Hefei, Anhui province

September 21, 2010.

REUTERS/Stringer




© Thomson Reuters 2010. All rights reserved.

Republication or redistribution of Thomson Reuters content, including by

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For comments, queries or tips:

Eric Burroughs

Editor, Asia Financial Markets

Phone: +852 2843 1652

[email protected]

Vidya Ranganathan

Economics Editor, Asia

Phone: +65-68703090

[email protected]

Cover Photo: participant takes part in the China Birdman contest in thesouthern Chinese city o Jiangmen in Guangdong province September 21,2010. REUTERS/Bobby Yip

– but they must invest frst in U.S. dollars, whichare then converted into yuan. new plan knownas the “mini-QFII” extends that to ong Kongbrokerages, and let them invest in yuan directly.

nother idea is or mainland companies to issueyuan-denominated shares in ong Kong. Morecompanies on both sides o the border will al-most certainly issue yuan-denominated bonds inong Kong – as Russian miner Rusal is about todo. currency orwards market may ollow; cur-rently there are only “non-deliverable” orwards,where no yuan changes hands.

But it won’t be quick. China has set a 2020 goalto develop Shanghai as a global fnancial centrecommensurate with the status o the yuan, and

China’s role in the world markets. So 2020 isseen as a tentative deadline or yuan interna-tionalisation.

SO IS TIS TE END OF TE DOLLR?

ardly. China probably covets the U.S. dollar’spre-eminence, and should overtake its biggesttrade partner in size as soon as 2025, by Deut-sche Bank estimates. Yet even once the yuanbecomes international, unseating the dollarcould take decades. global currency o choicemust be very liquid, and ully convertible.

global currency also needs to have investors’trust. The dollar, sterling, the euro and the yenare backed by countries with relative economicstability, sustained low ination and transparentinstitutions. China, despite much progress, lacksall three.

Finally, being the “new dollar” would come withstrings. Since the greenback makes up 62 per-cent o global reserves, most countries have avested interest in how the US runs its economy.

Everyone – especially China – is a critic. It ishard to imagine the People’s Republic welcom-ing such scrutiny.

– The authors are Reuters Breakingviews col-umnists. The opinions expressed are their own(Editing by ugo Dixon and David Evans)

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