China's Big Bang: Finding Real Value in the Yuan

by: Jim Trippon
Ask any American investor about the currencies of foreign nations and you'll probably get a right answer. Most of Europe uses the euro. Britain continues to trade with the pound sterling. Japan is well known for the yen.

But ask about the currency of the second biggest economy in the world and you may get a blank stare. China's yuan is also called the renminbi, or people's currency. It is much the same as the British reference to the pound as "sterling."

Few Americans know the yuan, or have ever touched a 100 yuan bill. That's because China has sharply limited foreign transactions in its national currency. That's changing very quickly and it's a trend that China investors should be aware of.


For several years, the Chinese have been critical of the world's reliance on the dollar. But Beijing hasn't been able to do much about it.

Because the yuan is not a freely tradable currency on global markets the Chinese have had little influence on the world's reserve currency.

Keeping the yuan locked inside China allows Beijing to control the value of the currency. But it severely limits the yuan's usefulness in global trade.

How the Yuan Drives Dollars to China

China has built up a mountain of foreign reserves, most recently estimated to be just shy of $2.5 trillion. As much as a trillion dollars is invested in U.S. financial instruments. China has been trying to pare down its investments in U.S. treasuries. But the yuan is preventing that from happening.

Consider the problem China faces by looking at a simple transaction. Suppose a Chinese exporter receives payment from a U.S. client for a shipment of goods. The American buyer has no choice but to pay his supplier in U.S. dollars because the yuan is not available as a currency for world trade.

The Chinese exporter faces another problem. He cannot legally use his new U.S. dollars within China. He must ask the government to buy his dollars and receive yuan. Multiply this transaction millions of times. That's how Beijing winds up with its national store of cash in foreign currencies.

With the instability of the dollar and the sharp decline in the value of the euro, the Chinese have good reason to look for alternatives. Gold is one possibility and China has encouraged its people to invest heavily in the precious metal. But that's a temporary fix. Too much Chinese demand for gold would drive the price through the roof.

China is now doing what it must do. It is beginning the complex process of internationalizing its currency.

Officially, China is approaching this process very cautiously. The nation's chief currency regulator, Yi Gang says China is in no rush to turn the yuan into a global currency.

The fact is, many non-Chinese are now demanding access to the yuan as a natural part of doing business. McDonald's Corporation (NYSE:MCD) is first out of the gate, selling 200 million yuan worth of corporate bonds yielding three percent. It is a signal of a sea change in Chinese business.

McDonalds will use yuan funds to finance the company's lightning fast expansion in China. Next in line will be Wal-Mart (NYSE:WMT) which says it too will sell yuan bonds.

According to Bloomberg, "There are hundreds of global companies wanting to do more business in China. They will want to be involved in the country's evolving credit market."

Among those companies are some of the world's financial giants. They include Citigroup (NYSE:C), HSBC Holdings (HBC), and CIMB Group. They all plan to apply to invest in yuan bonds.

HSBC, and Standard Chartered, are also offering discounted transaction fees to companies that choose to settle trade in yuan.

Among the others following this trend are JP Morgan (NYSE:JPM), and BBVA (NYSE:BBVA), Spain's second largest bank.

Private Equity Goes Chinese

Some of the world's largest private equity firms are competing to set up Chinese currency funds. The big names in this game are the Blackstone Group, the Carlyle Group and TPG.

A little known giant, TPG is teaming up with the Shanghai municipal government to create its newest fund. Together they expect to raise the equivalent of $735 million to create a fund entirely in Chinese currency. Blackstone and Carlyle are raising similar amounts for their yuan funds.

These funds will make it much easier for capitalists to operate in China. Previously, private equity giants using dollar funds had to jump through hoops to invest in Chinese companies. They had to set up complex offshore structures and seek listings on foreign stock exchanges.

China believes these pioneering yuan funds will help get money to Chinese businesses more quickly.

Keeping capital on the mainland also means that newly capitalized companies can list on the Shanghai or Shenzhen stock exchanges. All of this fits perfectly with Beijing's desire to turn China's financial capitals into global powerhouses, rivaling New York, London and Tokyo.

As the yuan goes global Beijing will lose some of its ability to control the value of the currency. Some investors are speculating that the value will rise.

Investors who can't access the yuan through forex markets may want to consider using ETFs.

There are two ETFs which can give you exposure to the yuan. They are the WisdomTree Dreyfus Chinese Yuan Fund (NYSEARCA:CYB) and the Market Vectors Chinese Renminbi/USD ETN (NYSEARCA:CNY). Trading in currencies can involve risk. But the signals are pointing to a yuan that might eventually become a global reserve currency.

Disclosure: No positions