Does the Yuan Have a Clear Advantage in the Global Currency War?

by: World Market Pulse

As the global economies, businesses and market trends change momentum towards the east, the relationship between a country's economy and its currency is getting much more complicated as governments across the globe are assuming a bigger role in propping up the financial system and encouraging economic growth. What started as a small echo with allegations of China knowingly undervaluing its currency has now grown into a currency war after the Japanese government's intervention in the currency markets by weakening the Yen for the first time in six years. This happened while the counter strike from the Dollar came, as the Fed announced the readiness to introduce a new round of quantitative easing to boost the economy. Such has been the impact of the recent currency games that IMF chief Dominique Strauss-Kahn has now joined those warning that governments are risking a currency war if they try to manipulate exchange rates to solve domestic problems.

Experts meanwhile feel that if the currency games continue for a long term, investor confidence in international currencies could break down to such an extent that it could lead to sharp changes in the near future. A few forex experts and analysts have expressed concern that Chinese Yuan could very well emerge as the next preferred currency of global trade as and when the dust settles down from the current tit for tat mechanism. If investor confidence is shaken up badly by the prolonged currency tug of war, the absence of any other credible alternative to the US dollar as the reserve currency of choice might just work in favor of the Chinese Yuan.

According to Joseph Yam, a former chief executive of the Hong Kong Monetary Authority, the yuan should become fully convertible, the domestic debt market in China should acquire depth, and a robust financial infrastructure should be put in place if the Chinese Yuan has to emerge as the preferred choice of the investors in the near future.

China and Hong Kong had earlier agreed to loosen rules regulating trading of the yuan in the territory in July, tweaking rules to allow the sale of yuan-denominated financial products and giving companies greater access to yuan funds. Much of the trade settlement business came from companies looking to re-denominate to yuan away from the US dollar, which most companies operating in China use to pay and issue invoices.

Although skeptics have questioned such a possibility because China as of now runs a balance-of-payment surplus by keeping its currency artificially pegged and they might find it extremely difficult to take the yuan global without changing its export focus. But Guonan Ma, senior economist at the Bank for International Settlements believes that it isn’t entirely necessary for the yuan to become fully convertible for it to be gradually internationalized. There is another argument saying that if China can work its way around the problem by building good institutions, established rule of law, property rights, and good corporate governance with long-term bond markets and stringent regulations.

Meanwhile China’s central bank, the People’s Bank of China, has already been trying to do this by establishing currency swap agreements with central banks around the world.

The depreciation of the Yuan compared to the Dollar has already caused a growing tension between the U.S and China in recent weeks. The U.S is blaming the cheap Yuan for its economic issues and even financial sanctions against China have been on the cards. If these two giant economies are starting to threaten each other, the impact on the ever-slowing recovery could be enormous.

Reality Of The Chinese Currency Drama: China, from its earliest civilizations has always been a clever economy and it's certain that it would not enter into an economic suicide by blindly imitating the west. It is also quite clear that the Chinese government would not allow their currency to go down with the dollar ship as most of the export dependent companies of China (which forms a big chunk of the current Chinese economy) may lose steam as most of them work on very thin margins. Although economists continue to be skeptical about the goodness of the Chinese currency moves, there is no doubt that China is ready to resume greater flexibility with its yuan.

Political Complications: Although financial analysts are divided over the issue, most political observers have been quite unanimous in saying that whether the yuan becomes more international if at all, politicians and Chinese policymakers are likely to lose their degree of freedom, as there would be deep international repercussions of their policy measures.

Whatever might be the case, most economists are of the view that the rise of the Yuan or renminbi is desperately needed as a multipolar system actually helps in stabilizing the international monetary system.

Disclosure: No positions