In this article, I will look at recent developments that show the Yuan is slowly becoming the global currency of choice for trade. I will cover two aspects of the Yuan in this article, foreign currency holdings, and currency settlement.
Foreign Currency Holdings
In an article on Bloomberg in November 2013, the People's Bank of China announced it would stop buying dollars (UUP) to add to its reserves of dollars. The reason why this is important is that by purchasing dollars the PBOC is slowing the appreciation of the Yuan, take that away and the Yuan should appreciate at a faster pace than it had in the past. The Bloomberg article brings up the point that, "Less intervention and smaller gains in foreign-exchange reserves may damp China's appetite for U.S. government debt." Which would mean the U.S. would have to find someone else to continue funding the governments' deficit spending.
Countries that do business with China or Chinese companies have started to settle trades and transactions in Yuan rather than US Dollars (USD). Three recent developments show that the Yuan will see an increased role as the currency used in trade.
The first development comes from Australia, just last week it was announced that the ASX [Australian Stock Exchange], and the Bank of China "will provide a Yuan settlement service to Australian and Chinese financial markets by mid-year." This new settlement service will make it possible for companies in Australia who do business in China to have those trades settled in Yuan rather than dollars.
The second development comes from South Korea, just last week an article by Bloomberg pointed out that South Korea and China are considering a direct trading partnership between the Won and the Yuan because China is the largest trading partner of South Korea. This again is a risk to the US Dollar because according to the article "South Korean exporters settled 84.6 percent of their payments in dollars." With China, being the largest customer that South Korea exports to increasing the use of the Yuan for payments would decrease the demand for dollars.
The third development comes from the U.K. where it was announced yesterday that the U.K. is in "active" discussions with China to establish a Yuan-clearing bank in London and this should be done in "fairly short order." The article also points out that sometime in the not too distant future there will be direct trading between the Yuan and the British pound. Again, the same pattern is repeating itself, with the Yuan expanding into financial centers worldwide and gaining traction as one of the major global currencies.
One of the potential challenges to my points above is that if the PBOC allows the Yuan to fluctuate more freely, there is the possibility that the Yuan could actually fall in value and be a more volatile currency than it is now. In a recent article, it was pointed out that small and medium size banks are having a cash shortage because of rising money market rates. What is causing this spike according to the article is "Talk of defaulting investment products are also shredding investor nerves, resulting in the third significant spike in rates since June last year." On the economy side of things, the February PMI for China fell to 48.3, which is the lowest data point in the last 7 months, and means that manufacturing activity contracted for February. While some of this may be due to the Chinese new year, the reading in January was contracting as well. The combination of a higher money market rate, and a contracting PMI is why the Yuan had fallen 0.67%.
Based on all the developments from above and the possibility of reducing buying of US government debt I believe it is clear that China is expanding its footprint throughout the currency realm, and preparing for the Yuan to continue to appreciate much higher from current levels in the long term. However, in the short to intermediate term the Yuan could continue moving lower because of the challenges I outlined above.
In closing, if the Yuan does continue to rise because of its increased use as a global currency, there are two ETFs, which should take advantage of the rise in the Yuan.
WisdomTree Chinese Yuan ETF (CYB)
Fund Description: "The WisdomTree Chinese Yuan Strategy Fund seeks to achieve total returns reflective of both money market rates in China available to foreign investors and changes in value of the Chinese Yuan relative to the U.S. dollar." [CYB Fund Page]
Expense Ratio: CYB has an expense ratio of 0.45%.
Other Information: CYB currently has $208 million in assets, and pays an annual dividend in December of each year that varies.
PowerShares Chinese Yuan Dim Sum Bond Portfolio ETF (DSUM)
Fund Description: "The Fund normally will invest at least 80% of its total assets in Chinese Renminbi (RMB)-denominated bonds that comprise the Underlying Index. The Underlying Index is composed of RMB-denominated bonds issued by governments, agencies, supranationals and corporations, excluding synthetics, convertible bonds, retail bonds and CDs." [DSUM Fund Page]
Expense Ratio: DSUM has an expense ratio of 0.45%.
Other Information: DSUM currently has $206 million in assets, and pays a monthly dividend of 3.30%.