The Yuan - will it soon become a reserve currency ?

Whilst several experts estimate the that it will still be about ten years before the status of the yuan changes to that of a reserve currency, the exchange agreement between Japan and China which replaces the dollar with the yen or the yuan, for bilateral trade, could accelerate this change....

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Until now, 60% of trade between China and Japan has been carried out using the dollar. But despite the historic conflict between them, Japan and China have indicated that form now, they are going to use the yen and the yuan for bilateral trade. This agreement will carry a lot of weight in world trade since both Japan and China are the 2nd and 3rd world economic powers respectively.

Japan has become China’s second largest trading partner whilst China is Japan’s most important trading partner, as well as its largest export market. The volume of trade has now reached nearly 300 billion dollars in 2010. This figure hardly reached 1 billion dollars in the first few years after the normalisation of bilateral relations between these two countries in 1972.

On the other hand, Japan has become the third largest source of foreign investment in China, investing over 77 billion dollars in 2010. During last April, China bought 16,6 billion dollars of Japanese long term bonds denominated in yen. In return, Japan plans to buy 10 billion dollars worth of Chinese bonds denominated in yuan.

A number of Asian countries, most of which, have signed free-trade agreements with China trading up to 80% in dollars, could follow suit.

The dynamic of the yuan

According to Phillippe Waechter, Head of Economic Research of Natixis Asset management, the evolution of China is extremely rapid, and both its accumulation of foreign reserves and its capability to destabilise or stabilise global constructions is(...)

The Central Bank of China announced on the 24 December, 2011 the signing of a credit swap agreement to the value of 10 billion yuans (1,5 billion dollars) with the State Bank of Pakistan. According to a press release on the bank’s internet site, the agreement will last for three years and is renewable, with the approval of both parties. The press release said that this agreement aims at reinforcing financial co-operation, promoting trade and investment between the two countries and maintaining financial stability within the region.

In an attempt to replace the dollar, China started, since the financial crisis of 2008, a policy of internalization of the yuan. China signed agreement swaps with 14 countries establishing, in particular, currency swaps with Argentina, Brazil, Indonesia, South Korea, Malaysia and Belarus.

China has also launched several issues of Treasury Bills in Hong Kong, which are available to foreign investors. This emissions market in offshore renmimbe is booming in less than two years. Besides Japan which has expressed interest in purchasing yuan-denominated bonds, in an attempt to diversify their reserves, Nigeria, which is a growing power in Africa, has also shown interest in this type of investment.

The President of the World Bank, Robert Zoellick considered that it would be a mistake for the United States to take for granted the position that the greenback holds as the reserve currency and to assume that the status of the American dollar would depend upon how the United States chose to manage the US debt. Two years ago, Bernanke, Chairman of the Federal Reserve, responding to a question that MPs had on Mr Zoellick’s opinion, stated that the establishment of a new reserve currency was "a long-term one" and that there was no immediate risk to the US dollar.

At the end of 2009, Nouriel Roubini predicted that, out of all the global currencies, only the yuan could replace the dollar as the reserve currency, but that it would take 10-12 years for this to happen. " Right now, the yuan is far from being ready to adopt the status of a reserve currency. China must first lower the restrictions on incoming and outgoing capital , make its currency entirely convertible for such transactions, introduce domestic reform and make its bond market more liquid. It will take a long time before the yuan becomes a reserve currency, but it could indeed happen" he explained in an interview with the Wall Street Journal.

Maxime Onan January 2012

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