It’s hard to know whether Washington or Tokyo should be most concerned over the fact that China is beginning to flex its muscles with regard to the international role of the yuan.
But judging from past experience, it appears likely that Japan will respond to China by competitive moves to promote the yen. This would be a great pity. The world badly needs a third reserve and transaction currency to complement a declining dollar and an emerging euro.
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Yuan could become Asia’s leading currency
By ANTHONY ROWLEY
12 June 2009
It’s hard to know whether Washington or Tokyo should be most concerned over the fact that China is beginning to flex its muscles with regard to the international role of the yuan.
The desire by some Chinese bankers to have foreign entities issue yuan-denominated bonds certainly implies a further blow to dollar hegemony but equally it suggests that the Japanese yen has missed its chance for greatness.
Guo Shuqing, chairman of the China Construction Bank (CCB), one of China’s main state-controlled banking entities, this week called upon the US government and the World Bank to consider issuing yuan-denominated bonds in Hong Kong and Shanghai. The fact that Mr. Guo is a former head of China’s official Foreign Exchange Administration authority added weight to his call.
The significance of his comments (made in New York as CCB’s representative office there was upgraded to branch status) goes beyond the mere technicalities of bond markets. It suggests that China is anxious to establish an equivalent of Japan’s Samurai Bond market (where foreign governments and other entities issue yen-denominated debt securities) in pursuit of wider strategic ends, and also that it is prepared to liberalise its foreign exchange controls.
This would be an important step on the road towards internationalisation of the yuan and also towards turning it into a reserve currency. It would allow China to make the same demands that Japan’s opposition Democratic Party has said it will make once it is in power - that if the US government wishes to continue borrowing money from Japan, then it must do so in yen rather than dollars.
Washington had a rather unhappy experience of issuing foreign-currency sovereign debt (so-called Carter Bonds) back in the 1970s when the dollar was weak. It does not seem anxious to repeat the experiment but beggars cannot be choosers and with a massive budget deficit to fund in coming years, the Obama administration may have little choice but to borrow in the currencies of its two main foreign creditors, China and Japan.
If the US were to issue debt denominated in yuan rather than dollars, it would have an obligation to repay in a currency that is generally assumed to be likely to appreciate against the dollar in the medium to long term. Washington would lose the privilege of deciding the currency - its own - in which it is prepared to borrow from other countries. As for the World Bank, if it too were to borrow in yuan, it could use the proceeds to finance loans within China, or ask China to swap yuan for dollars - presumably with the World Bank taking the exchange risk.
However, if China moves more quickly than generally expected to liberalise foreign exchange transactions, then borrowers of yuan - be they the US government or anyone else - could swap yuan for any currency they wished.
However such transactions are handled in practice, it is clear that the days when US authorities or multilateral organisations such as the World Bank and the IMF and etc were able to borrow at will in dollars with no questions asked are coming to an end. This is a reflection of the bargaining power acquired by Washington’s two main foreign creditors.
But what does wider enfranchisement of the yuan and accompanying liberalisation of China’s foreign exchange control regime mean for the future of the yen? Since China’s economy is set to outgrow Japan’s and China’s trade with the rest of Asia to exceed Japan’s, the yuan is likely to become more important as a regional currency than the yen. This has remained only a theoretical possibility for as long as the use of the yuan was restricted in both current and capital account transactions. But the maturing of the yuan as a fully convertible currency is beginning to look more likely now. Indeed, given China’s rapidly expanding weight in the global economy and world trade, the yuan could be set for a major role on the international stage.
Japan missed its chance to make the yen the ‘Deutschemark of Asia’ by declining to pursue this goal actively enough in the 1970s and 1980s. It dithered over liberalising its capital markets for fear of letting in too much foreign influence. By making China a production base for its exports, Japan also passed onto China much of its influence as a trader. Japan can save itself from further decline only by openly embracing economic and monetary union with China, as part of a wider Asian integration. That way, a composite currency unit or basket could emerge - possibly an Asian Currency Unit or ACU.
But judging from past experience, it appears likely that Japan will respond to China by competitive moves to promote the yen. This would be a great pity. The world badly needs a third reserve and transaction currency to complement a declining dollar and an emerging euro.
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