China's Yuan Won't Dethrone Dollar Anytime Soon
Chinese Vice President Xi Jinping’s swing through the U.S. this week is getting the royal treatment from the Obama administration—understandably so, given that Xi is the probable successor to President Hu Jintao. The visit is sure to animate hawkish members of Congress over China’s currency policy, as well as enliven the broader debate among economists over whether the yuan is on a trajectory to dethrone the dollar as the world’s dominant currency. Putting aside whether or not the yuan is grossly undervalued, are we about to see the rise of another Yuan Dynasty in which a big chunk of world trade and international investments will be transacted in paper notes bearing the image of the Great Helmsman, Mao Zedong? The short answer: very unlikely, unless Beijing officialdom is ready to give up enormous financial control over its 1.3 billion-plus citizens.
There’s no denying that the Chinese currency is starting to emerge as an important trading currency. Just this week, Hang Seng Bank (11:HK) launched the world’s first yuan-denominated gold exchange-traded fund (ETF) on the Hong Kong stock exchange in a move designed in part to broaden the currency’s circulation in a crucial market. The yuan’s international profile received an earlier boost in December, when Japan and China agreed to a wide-ranging currency pact, in which Japanese institutions will be allowed to sell yuan bonds in China. In return, Tokyo will buy up to $10 billion worth of Chinese government debt for its foreign currency reserves.
Arvind Subramanian, a senior fellow at both the Peterson Institute for International Economics and the Center for Global Development, foresees the yuan displacing the dollar as the world’s main reserve currency in 10 years. He sees parallels with the relatively abrupt shift from the British sterling to the dollar as the No. 1 currency in the years following the end of World War II. Last fall, Subramanian argued in an online debate hosted by Economist.com that once an economy becomes dominant in a general sense, “currency ascendancy follows within about 10 years.” China, the world’s second-largest economy, doesn’t have the U.S.’s epic debt problems, he argues. The country also is awash in foreign currency reserves and is a net international creditor. That makes more yuan more attractive, Subramanian says.
However, it’s hard to imagine Subramanian’s speedy global dethronement of the greenback. At last count, the yuan had only a 0.3 percent worldwide share of global foreign currency transactions, vs. 85 percent for the dollar, according to the Bank for International Settlement’s 2010 Triennial Central Bank Survey. The U.S. economy, with all of its shortcomings, isn’t postwar Britain. A second challenge for Beijing (a big one that Subramanian acknowledges) is that China’s capital account is pretty much closed, the yuan isn’t freely convertible, and few foreign investors have unfettered access to mainland financial markets. That, plus a politically connected, largely state-controlled banking system, gives Chinese authorities enormous power over capital flows and the overall economy. Subramanian and others argue that China will eventually adopt a more modern financial system and liberate the yuan.
That optimism seems unwarranted, given the sporadic social unrest China has experienced in recent years over income inequality, government corruption, and world-class environmental air- and water-pollution problems. If China opens up its capital regime, a lot of capital might just flee the country in search of better returns than those available at home. Such a scenario would hurt the state-owned banks and local markets—both big sources of wealth for Chinese government officials. Unless you envision China’s one-party and financially repressive state embracing radical reform at any time soon, count on the dollar (not to mention the euro and yen) continuing to bask in the spotlight.