The People’s Currency

(Bloomberg) -- China is an economic giant, but its money is still a bit of a runt. Unlike the U.S. dollar, euro and British pound, it’s little used away from home. The No. 1 exporter has kept its currency off world markets in the past and still restricts buying and selling. That's walled off China from boom-and-bust capital flows and kept its goods cheap. Now it has reason to loosen the grip on the renminbi, which means “the people’s currency,” and is better known by the name for its biggest unit, called yuan. To fuel a slowing economy, attract foreign capital and back rising political ambitions, China is promoting the use of the yuan throughout the world, a slow-moving process known as internationalization. It’s one of the biggest changes since the creation of the euro, a beckoning bonanza for bankers and traders — as well as a threat to China’s economic stability and credibility. 

The Situation

U.S. President Donald Trump has branded China a “grand master” at currency manipulation, a nation that effectively taxes overseas goods by keeping the yuan undervalued. Yet following a surprise devaluation of the yuan in August 2015, Chinese authorities shifted their focus to supporting the currency, burning through $1 trillion, or one-quarter, of foreign-exchange reserves by early 2017 and tightening rules on money leaving the country. After the currency reached its lowest level on record at the end of 2016, its strengthening continued into 2018 as the U.S. dollar weakened and prospects for the Chinese economy brightened. In another sign of how geopolitics can alter priorities, top Chinese officials in April were said to be weighing the potential impact of a gradual yuan depreciation as a tool in any trade war with the U.S., or as a move to offset reduced exports caused by a trade war. Private investors — both Chinese and non-Chinese — can legally move their money in and out of the mainland only through approved programs and in limited amounts. But companies and individuals have found ways to get their funds overseas, with favored methods ranging from buying insurance policies to foreign property. The yuan's fluctuations have continually tested a pledge by the government to give market forces a bigger role in determining the exchange rate. At the same time, the yuan's internationalization has a long way to go: China accounts for more than 10 percent of world trade, but less than 2 percent of global payments are made in yuan. In moves that may signal wider use ahead, President Xi Jinping pledged 100 billion yuan of funding for his “Belt and Road initiative” and central banks in Europe have included China's currency in their reserves. 

The People’s Currency

 

The Background

China has been reluctant to open its doors throughout history; a scornful 1793 letter from the emperor to King George III dismisses all requests to ease restrictions on British traders. The economy was closed to non-socialist countries under Mao Zedong for 30 years and then China started liberalizing at its own pace, an approach the late leader Deng Xiaoping called “crossing the river by feeling the stones.” In 1994, it set a fixed rate for the yuan against the U.S. dollar, a peg that endured for a decade. After China joined the World Trade Organization in 2001, selected foreign institutional investors were permitted to buy yuan-denominated stocks in limited amounts. The yuan’s peg was dropped in 2005 and then unofficially slapped back on in 2008 to insulate China from the global financial crisis. In 2010, China’s economy overtook Japan as the world’s second-largest and yuan use took off. In 2016, the yuan joined four other currencies in the International Monetary Fund's Special Drawing Rights, a kind of overdraft account it holds for global central banks. That was a milestone some analysts estimated could trigger a $1 trillion switch into Chinese assets. The country’s leaders have said they aim to make the yuan convertible by 2020. More than a dozen countries are vying to become yuan trading hubs and have signed emergency swap agreements. Inside China, the yuan can trade 2 percent on either side of a daily fixing set by the central bank; a freely traded offshore rate tracks it.

The People’s Currency

 

The Argument

The U.S., which had scolded China on and off for decades for keeping the exchange rate weak to boost exports, stopped calling the yuan “significantly undervalued” and backed its bid for IMF reserve-currency status in 2016. Yet Trump revived the criticism and has announced plans for tariffs on imports from the country, though he went back on a campaign pledge to brand China a currency manipulator. The yuan’s advance into global markets demonstrates Xi's ambition to challenge the hegemony of the dollar and a global economic order dominated by the U.S. and Europe. Inclusion in the IMF's reserve-currency basket is expected to accelerate the pace of reform. A more widely used currency would raise China’s influence in setting prices of commodities from oil to iron ore and give individuals and companies on the mainland more choice with their savings. As the yuan makes the long march to convertibility, China becomes vulnerable to swings in the currency and money flows that could aggravate its economic challenges.

The Reference Shelf

(Fion Li and Robin Ganguly contributed to an earlier version of this article.)

First published April

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