By: Dr. Mike Campbell
China is now the world’s second largest economy and the Chinese have made it clear that they would like to see the Yuan become established as a reserve currency for the settlement of international trade. If this is to happen, then the Chinese will have to allow much freer access to the Yuan.
In what might be the first move towards greater accessibility to the Yuan from foreign countries, China has agreed to let Japan invest $10 billion in its government bonds. China and Japan hold the biggest reserves of foreign exchange and entered into an agreement which permitted direct exchange of their currencies (without the need to convert them to US Dollars first). The idea behind this was to cut business costs and to boost bilateral trade. By allowing such direct foreign investment in the Chinese debt market, China hopes to boost international acceptance of the Yuan.
At the moment, China does not permit foreign investors to buy government bonds freely and has maintained a firm grip on investment of Yuan-denominated assets by outsiders, but this would have to change if the currency is to play a less marginal role.
China has suffered near constant criticism that the value of the Yuan is being kept artificially low against other major currencies. Whilst it is true that the Yuan has been allowed to appreciate against the Dollar, it is certainly not trading freely. It has appreciated by 8% against the Dollar since the summer of 2009, but the Yen has gained 15% over this time. It is clear that in macroeconomic terms, the Chinese economy is faring much better than the Japanese and were the Yuan to truly be a free currency, it would have enjoyed safe haven status (as the Yen has), pushing it considerably higher against the Dollar. It is clear that the Yuan will be forced higher over time if it does play a larger role on the world’s stage. This, in turn, will put pressure on Chinese exports as they lose their price advantage.