The Internationalization of the Yuan



The issue of turning the yuan into an international currency is the subject of much controversy. Some believe that Beijing should opt for full convertibility of the yuan, turning it into a fully-fledged international currency. Others believe that the yuan is already an international currency, citing impressive figures that reflect the growing use of the Chinese currency in international trade. Still others hold the view that turning the yuan into an international currency would be of no benefit to Beijing, and the Chinese authorities are even intentionally preventing it. The complexity of the problem lies in the fact that moving the yuan towards internationalisation involves three distinct phases: turning the Chinese currency into a) a trading currency, b) an investment currency, and c) a reserve currency…

The yuan as a trading currency

The process of turning the yuan into an international trading currency began after the 2007-2009 financial crisis, which exposed the precariousness of the world’s leading currencies – the dollar and the euro. China’s main trading partner was, and still is, the US, and the only currency used in China’s foreign trade with America is the US dollar. However, the dollar does not just predominate in China’s trade with the United States, but with other countries as well. The first steps towards the internationalisation of the yuan emerged in 2008-2009. At that time, businesses and companies were allowed to use the yuan in trade with Hong Kong(Xianggang), Macau (Aomen), and ASEAN countries. In the middle of 2009, just 365 companies had the right to use the yuan in international trade transactions, but by the end of 2010 this number had grown to 76,359. In 2012, every Chinese company with a licence for export and import transactions was able to use the yuan. An active transition to foreign trade settlements in yuan is happening alongside an increase in the use of the national currencies of China’s trading partners. This is being facilitated by the signing of bilateral currency swaps between the People’s Bank of China (PBC) and the central banks of China’s trading partners. To date, the PBC has signed more than 20 currency swap agreements. While just 3 per cent of China’s foreign trade was settled in yuan in 2010, by the end of 2013 this figure had reached 18 per cent. And according to HSBC forecasts, this share is expected to grow to 30 per cent by 2018.

At the end of 2013-beginning of 2014, the yuan overtook the euro in terms of the amount of payments used for international trade, and took second place after the US dollar. It is significant that the yuan is even being used in trade between China and the US, although its share of the bilateral trade between China and the US does not yet exceed 2 per cent.

The position of the yuan in the total number of international currency transactions in the world is much more modest. Besides being used to settle trade in goods and services, the Chinese currency is also used to exchange for other currencies (the foreign exchange market) and for a variety of credit and investment transactions (stock and other financial markets). Ten years ago (in 2004), the yuan was only the 35th most internationally traded currency. At the beginning of 2012, it had risen to 13th place, and at the beginning of 2014, the Chinese currency was already in 7th place, having overtaken, for example, the Swiss franc.

On the convertibility of the yuan

The position of the yuan in the overall number of international currency transactions largely depends on its convertibility. At the moment there is partial convertibility, which means it is possible to freely use the yuan for current transactions, first and foremost trade transactions. Partial convertibility was introduced in 1996, and at that time the Chinese authorities declared another ten years would be needed to move to a fully convertible yuan, so to lift restrictions on capital transactions, in other words. Eighteen years have passed since then, however, and the restrictions are still in place. Obviously, turning the yuan into a freely convertible currency would drastically increase the scale of the yuan’s use in global currency turnover, but this would only be a short-term effect, and the risks to the Chinese economy would rise sharply. Until comparatively recently, the yuan was a currency with a fixed exchange rate that was also undervalued, which made it a tool for the active expansion of China’s foreign trade. Since the 2000s, Beijing has refused to administer the exchange rate; officially the exchange rate became floating, but adjustable. It is regulated by the People’s Bank of China which, by systematically buying up dollars, euro and other currencies, is artificially curbing the growth of the yuan’s exchange rate, keeping it at a lower level than the purchasing power parity of the yuan and the dollar. If the yuan becomes fully convertible, then there is a risk that the PBC would lose control of the exchange rate of its own currency, and this would be a direct threat to China’s current economic model, which is based on trade expansion. China’s economy, even with its undervalued yuan, is already facing certain problems since the global market is saturated with Chinese goods and further export expansion is difficult. The issue of the exchange rate regime of the yuan will be decided depending on what the future model of China’s economy turns out to be, but the country’s leadership is not fully in agreement on this matter. Without a clear long-term economic development strategy, however, the transition to a freely convertible yuan will end up being a concession to pressure from the West and will come with serious risks.

Unofficial statements by Chinese leaders that it would be a good idea to make the yuan a freely convertible currency first appeared in 2011, as the country marked the 35th anniversary of the death of Mao Zedong. The Third Plenum of the Central Committee of the Communist Party of China was held in November 2013, at which two camps revealed themselves: a) those in favour of the development of the domestic market and China’s transformation into a country with a developed and independent economy; and b) those in favour of China’s rapid integration into the global capital markets. Official reports said that the country would move towards a full convertibility of the yuan. This means that the second camp got the advantage, and the supporters of the first camp only managed to ensure that the transition to a freely convertible yuan would be gradual rather than abrupt.

Moving towards investing in yuan: five small steps

Yuan used in foreign trade accumulates in the accounts of foreign companies that supply goods to China. Nowhere near all of the export revenues are used by China’s trade partners for the subsequent purchase of goods in China with this same yuan. According to the PBC, there was more than 1.3 trillion yuan overseas at the end of 2013, which is equivalent to approximately US $250 billion. In fact, this money is forming an offshore yuan market. It is as though two types of yuan have emerged: a) onshore yuan (yuan that is kept and circulated within China); and b) offshore yuan (yuan that is kept and circulated beyond China’s borders). Their values are not the same and they have separate exchange rate quotes.

Any further dynamic development of trade in yuan is only possible if a way is found to quickly use the yuan accumulated abroad. It is possible to use the yuan to buy goods in China, of course, but foreign holders of yuan would like to widen their range of possibilities. Namely: a) changing yuan into other currencies as required; and b) buying not just goods in China, but also assets (i.e. investing in the Chinese economy).

One of the steps towards turning the yuan into a freely convertible currency is the signing of an agreement between China and other countries on the conversion of the yuan into other currencies. At present, the yuan can be directly converted with the US dollar, the Japanese yen, the Australian dollar, the Russian rouble, the Malaysian ringgit, and the New Zealand dollar. The latest such agreement was signed between China and New Zealand in March 2014.

A large amount of yuan received by China’s trade partners is piling up in bank accounts in Hong Kong, which has been dubbed the offshore yuan market. At the beginning of this year, yuan deposits amounted to nearly 12 per cent of all deposits in Hong Kong’s banking system (in 2008 this figure stood at just 1 per cent). Simplified coordination procedures are permitted between this offshore market and China’s domestic market, which make the Hong Kong yuan more convertible. Hong Kong is acting as a kind of gateway between China’s domestic market and the global market.

After Hong Kong, London is the second biggest offshore market where the yuan is traded. At the beginning of this year, just four offshore markets that traded the yuan with a wide range of other currencies were in operation: Hong Kong, London, Singapore, and Taiwan. Another location is expected to emerge this year – in Frankfurt. The People’s Bank of China and the Bundesbank have agreed to establish a centre for the clearing and settlement of payments in yuan.

Since December 2010, the yuan has also been traded against the Russian rouble on the Moscow Stock Exchange. Exchange trading in the rouble-yuan pair was simultaneously launched on the Shanghai Stock Exchange. Based on the figures for 2013, trading volumes in the yuan-rouble pair were 3.5 times higher in comparison to 2012, amounting to more than US $100 billion.

Yuan trading on various trading platforms increases the demand for the Chinese currency, but the main question remains: what can the yuan accumulated be invested in? And this once again raises the issue of the yuan’s full convertibility. To accomplish this, it is necessary to liberalise the access of foreign investors to China’s domestic market on the one hand, and remove restrictions on the export of capital from China on the other. Small steps in these two directions are being made every year and, at the present time, almost every month.

According to IMF recommendations (which are as good as demands), for the country to be able to announce the full convertibility of its currency, it must have well-developed domestic financial markets. In a broad sense, therefore, convertibility involves not just the opportunity to buy and sell currencies at the market (floating) rate, but also the free purchase and sale of bonds and shares (the convertibility of securities). Generally speaking, there is already a capital market in China, and it is third in the world in terms of total capitalisation. As experts say, however, the domestic financial market is still not very flexible, and is under strong administrative pressure from the state. In 2014, Beijing announced the liberalisation of credit interest rates, which, according to Western experts, is a significant step towards the creation of a fully-fledged domestic capital market.

The Shanghai Free Trade Zone, which foreign investors have access to, began operations in September 2013. It is a unique experimental platform where full conversion of the yuan is allowed. At the beginning of 2014, the People’s Bank of China issued bonds worth 2.5 billion yuan, and the securities were floated in London. At approximately the same time, the China Securities Regulatory Commission issued a license for direct investment in China to a British management company. It is the first time that such a licence has been obtained outside Hong Kong or mainland China. In January 2014, a Chinese exchange-traded fund (ETF) started trading on the London Stock Exchange. The particularly close relationship between Beijing and London is visible to the naked eye. Anglo-Chinese relations were given another boost on 31 March 2014, when the Bank of England and the People’s Bank of China signed an agreement on the establishment of a yuan clearing house in London.



According to International Monetary Fund standards, the world reserve issuing country has to possess 1) large GDP, 2) stable currency, 3) capacious and liquid markets.

China faces problems with the third yardstick. Financial experts believe that only the countries with fully convertible currencies can have capacious and liquid markets among other things.

China cannot simultaneously continue the global commercial expansion and make the yuan become a reserve currency. The yuan’s rate needs to be low to facilitate the expansion but becoming a reserve currency requires the rate to be high. The leading world reserve currencies have rates much higher than the issuing countries’ purchasing power parity. All issuing countries are rich. They get profits not at the expense of production and export of commodities but rather international movement of capital. The «gold bullion» countries use to their advantage the privileges of being issuers of world reserve currencies. They attract goods and services from the entire world paying in bank notes – the types of promissory notes to be accumulated forever and never be paid off.

To become a world reserve issuing country China will have to lose its markets. 

The reserve currency issuing countries have balance of payments deficits. It means that a reserve currency is a trap. Back in the early 1960s Belgian-American economist Robert Triffin said there is a fundamental incompatibility between the attainment of US global economic stability and having a single national currency perform the role of the world’s reserve currency. He also noted another fundamental thing – the currency issuing country has to run adeficit of payments balance. In its turn the deficit undermines the reserve currency. Developing the Triffin’s ideas, some economic experts have come to the conclusion that a national currency cannot be a world reserve currency. Others say it can if it has the support of military. One day the contradictions related to the use of national currency as a world reserve one may lead to a large-scale war to null the issuer’s financial liabilities.

The dollar started to function as a real reserve currency only when the United States foreign trade deficit became stable. 

In the 1960s America started to lose the status of world manufacturer offering the world its greenback and IOUs in treasury bonds. Uncle Sam has been maintaining the demand for the production of the Federal Reserve System with the help of aircraft carriers and bombers. The yuan used as a reserve currency is a real trap for China – afterwards it will have either to «step back» and free itself from the woven web (but it won’t get back the external markets) or promote the yuan’s international standing with the help of military might. The latter does not correspond to the Beijing’s plans.

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Some countries have experience of being subject to the temptation of converting the national currencies into the world reserve ones to substitute the US dollar. They have paid a heavy price. Take Germany and Japan. In the early 1970s of the XX century the United States stopped the gold for dollar exchanges and devaluated its currency to cause disappointment on the part of European partners. «The dollar is our currency, but your problem» is a phrase that John Connolly, US Treasury Secretary under President Nixon, used to a delegation of European visitors in 1971 to cause wide discontent in the old continent. The statement still has a ring to it. Europe decided to respond by strengthening the national currencies and gradually squeezing the greenback out of the European trade turnover. What happened next? In the early 1970s, the European trade mainly used the US dollar for payments. In the early 1990s, over 50% of commercial transactions were done in German marks (Deutsche Marks). Its share in world gold reserves went up to the highest 20%.

There was a feeling that Europe starts to get rid of US dominance, including the American banking system. 

The unification of national currencies to establish the euro was the time of European heyday. Some savvies predicted the euro will take the place of US dollar as a leading reserve currency. Then, the euro share in world reserves started to dwindle like a bolt from the blue while the dollar showed the trend to restoring the previously lost positions. A bit later Europe was hit by crisis, especially the group of PIIGS (the economies of Portugal, Italy, Greece and Spain). At first, the German mark, then the euro abruptly sparked like shining stars to fade away soon.

By and large the same thing happened with the Japanese yen. At first the «Japanese miracle» took place in the 1960-70s leading to sudden increase of the yen’s share in world currency system. By the end of the 1970-80s some analysts started to say that the yen may become a real competitor for the dollar as a reserve currency. Those days it seemed that the Japanese government deliberately slowed down the process trying to contain the rate. Washington exerted great pressure, including the threat of economic sanctions, to make Tokyo sign an agreement with the United States on lifting restrictions on cross-border capital flows facilitating the access of American financial firms to the Japanese markets. The yen/dollar agreement, liberalizing Japanese capital markets, was signed in 1984. In a year’s time, the well-known Plaza Accord (or Plaza Agreement) was signed between the governments of France, West Germany, Japan, and the United Kingdom to depreciate the US dollar in relation to the Japanese yen and German mark by intervening in currency markets. The five governments signed the accord on September 22, 1985 at the Plaza Hotel in New York. As a result the yen rose over 50% in relation to the dollar. The rise of the yen led to the emergence of huge financial bubble in Japan. It was done away with only by suffering serious losses and applying great efforts. Japan could not recover afterwards and has been facing permanent economic stagnation ever since. The yen world share reached its peak at about 10% to go down afterwards and descend to less than 4% today.

There was only one time in the XX century when one currency substituted another to fully function as world reserve money (including a world reserve currency). The currency in question was the dollar of the US Federal Reserve System taking place of the British pound sterling. The change was taking place against the background of two world wars. The transitory period lasted for 30 years since August 1914 to in July 1944.

It took millions of human lives to squeeze out the pound so that the US dollar could take its place. 

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There is little possibility the yuan will replace the US dollar as a world currency. The development of events in the world of international finances may unfold according to other, quite different, scenarios.

For instance, the yuan could become a regional currency. 

For instance, it could become the currency of ASEAN (the Association of Southeast Asian Nations). It could also become the reserve currency of economically backward countries which find it rather hard to accumulate dollars, euro and other reserve currencies. The process of opening their markets to China as the main trade partner is already obvious. For instance, three and a half years ago Nigeria was the first African country which announced the decision to consider adding the yuan (the Renminbi) to the basket of reserves. It has been joined by some a number of other African states. China has special relationship with many states of Latin America. The National Bank of the Republic of Belarus stands out among others officially announcing the intention to use the Chinese yuan as a world reserve currency. As far back as the September of 2013 the Bank informed that it added the yuan to its gold and foreign currency reserves. According to various sources, the central banks of Malaysia, South Korea, Cambodia, the Philippines and Russia.

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Thus, de-facto the yuan has to some extent has become a reserve currency for some states while de-jure it still has a long way to go for becoming an alternative to the dollar. 

The International Monetary Fund has the last word to determine the status of a currency. According to it, there are four key international currencies today: the US dollar, the euro, the British pound sterling and the Japanese yen. The special drawing rights (SDR – supplementary foreign exchange reserve assets defined and maintained by the International Monetary Fund) for international payments are calculated daily from this basket. The basket of currencies that values the SDR is re-considered by the IMF every five years. In 2009 China made a proposal to add the yuan and other foreign currencies to the SDR basket to decrease the share of the dollar. The current structure of SDR is as follows: the dollar – 41, 9%, the euro – 37, 4%, the pound – 11, 3% and the yen – 9, 4%.The basket is to be valued again in 2015. One can be sure that once again China will raise the issue of adding the yuan to the SDR basket and the United States will oppose the measure. The issue of yuan status adds to the disagreements tearing the International Monetary Fund apart. These very contradictions are getting exacerbated inside the IMF. It pushes China and other countries that belong to the periphery of world capitalist economy to creating alternative financial structures. This summer the BRICS summit was hosted by Brazil. The parties signed an agreement on creating a Pool of Conditional Currency Reserves. The agreement involves provision of mutual financial support by the member countries of the BRICS. This support can be provided via immediate provision of liquidity to a country in need by other members of the Pool. The initial volume will make $100 billion (the share of China is 41%). The Pool is ‘conditional’ – this means that reserve assets of the participating countries will not be used until a decision on granting an application will be made by the Standing Committee of the Pool, which will include representatives of all five countries. At first it is envisaged to provide credits inside BRICS in world reserve currencies (first of all the US dollar). But it’s not excluded that in future the Pool will be added by the yuan and other national currencies of the member – states.



Valentin KATASONOV | Strategic Culture Foundation

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