While the West tries to preserve the power and the glory of another time, the people with the plans and the determination to reshape the world are in Beijing and Moscow.
It has been a gradual, cautious journey from obscurity to the second most important currency in the world. The Chinese yuan achieved that standing at the end of 2013.
According to the Society for Worldwide Interbank Financial Telecommunication, the yuan held an 8.66 percent share of letters of credit and collections in October, compared with 6.64 percent for the euro. China, Hong Kong, Singapore, Germany and Australia were the top users of yuan in trade finance.
The milestone achievement was followed in March with the Chinese agreeing to the establishment of clearing banks in London and Frankfort to make trade in yuan a normal part of international commerce. These new facilities expand the trading of the yuan beyond Shanghai and Hong Kong and indicate a careful selection of the expanding role of the currency.
London is a major financial center and accounts for 62 percent of foreign exchange trade. Germany is the fourth largest economy in the world and an important trading partner.
The journey to the heights began in 2005 when the People’s Bank of China (PBOC) began a controlled float of the yuan against the U.S. dollar. Over nine years, the yuan has appreciated about 35 percent.
At the beginning of its development, China had adopted a model employed by Japan, South Korea, and Taiwan to promote rapid economic growth. The three models had used international trade, especially with the United States, to provide markets for goods at the lower end of the manufacturing sector. It required a plentiful, low cost labor force for labor-intensive manufacturing and an underpriced currency.
By 2005, the first phase of the rapid economic expansion had been achieved. Low-cost, unskilled labor producing cheap goods was being replaced by higher paid, skilled workers who were moving steadily up the economic ladder by producing higher quality goods.
An undervalued currency was creating inflationary pressure internally and diplomatic strains internationally. The float was intended to reduce both problems. What developed was the secondary effect of creating the beginnings of a yuan bloc with Singapore, Thailand, Malaysia, and the Philippines tying their currencies with a soft peg to the yuan. The peg was hardened in 2009 and South Korea as well as Indonesia joined the bloc.
The informal grouping was not dictated by Beijing. It was simply the recognition by the members that their trade relations with China were more important than relations with the United States. By having their currencies moving at the same rate as the yuan against the dollar, one factor of uncertainty has been removed from the trade.
At the same time, the dollar remains, for the bloc members, the currency in which international loans and other financial arrangements are transacted. Unlike the U.S. dollar, in which 87 percent of trade is financed, or the pound, the euro, the Swiss franc, and the Canadian dollar, the yuan lacks the liquid government bond market that is essential to enable it to be used as a reserve currency. It is the only one of the largest six economies that does not qualify as a reserve currency.
Since mid-2010, the Renminbi trade settlement scheme introduced currency swaps with some 23 trading partners from Iceland to Japan. Because of the steady appreciation of the yuan, foreign buyers have been reluctant to buy in the Chinese currency that will cost more in the future. Only 17 percent of trade has switched to the yuan.
The arrangement is the closest that the PBOC has come officially to the establishment of a reserve currency, but it may no longer be up to the PBOC to decide. Forty various central banks have begun holding yuan, and by doing so, creating a reserve currency even before China has allowed it to float freely.
Jukka Pihlman, formerly with the International Monetary Fund and currently Standard Charterer’s global head of central banks and sovereign wealth funds, explained, “Central banks and sovereign funds have special treatment. They have the ability to invest in a way that any other investor does not have. When it comes to convertibility, there is nothing formally out there, but it is fully convertible.”
Private speculators discovered the yuan long before the central banks decided to begin to hold it. Once the PBOC began the controlled float in 2005, holding the yuan was a guaranteed profit for the speculators. They could borrow yen during the time that it was the focus of the carry trade, or the U.S. dollar that was on a stealth depreciation as a result of the quantitative easing program.
