A tradable yuan can weaken the dominant dollar
October 18, 2011, Tuesday
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Print Edition
Print Edition
IF China's trade with other countries was conducted using yuan instead of US dollars, the Chinese dependency on the US in this matter would disappear.
While more than 90 percent of imports to the US is invoiced in dollars - and an even larger part of exports - only a fraction of China's trade is invoiced in yuan. In order to increase this share, China has in the past couple of years made currency exchange arrangements with a number of countries. The purpose is to facilitate the use of yuan as a currency for invoicing and settlement.
But what should the countries that accumulate a surplus in Chinese yuan do with this surplus? Leave it as a foreign currency reserve in the central bank? That would presuppose that the Chinese government will permit the investment of the funds into financial assets in China.
If a gradual appreciation of the Chinese currency takes place, such reserves would give a good return. In addition there will be a diversification premium.
But as long as the yuan is not fully convertible, the availability of financial assets remains quite limited. This makes the yuan less suitable as a reserve currency in other countries' central banks.
In March 2009, the head of the People's Bank of China Zhou Xiaochuan shared his thoughts concerning the need for a reform of the international monetary system. He maintains that special drawing rights, which the International Monetary Fund at irregular intervals grants its member countries, should replace part of the international role of the US dollar.
The value of SDR is calculated on the basis of a basket consisting of four currencies - US dollars, euros, Japanese yen and British pounds. Currently, SDR stands for seven per cent of the world's total currency reserves.
SDR is almost never used in private transactions. Therefore it lacks liquidity. When SDR is used as settlement in transactions between countries it first has to be converted into a currency.
Or as professor Charles Wyplosz puts it: "SDR can be seen as a store of value waiting to be converted into dollars to be used as a medium of exchange."
The US dollar did not assume its role as the leading international currency by way of deliberate international decisions. Just as one cannot decide that Esperanto will replace English as the leading international language, one cannot decide that the yuan, or special drawing rights in the IMF for that matter, will replace the US dollar as the leading international currency. One might wish for it, but that does not make it come true.
If the dollar is to be dethroned from its position as the leading world currency it has to be through the emergence of better alternatives. Over time the euro might play a larger part. And gradually also the Chinese yuan.
However, it will most likely be a decade or two before the dollar's leading position becomes threatened.
One thing that may weaken the role of the dollar, though, is a persistently high US inflation rate. If such inflation is mixed with relatively low US interest rates, central banks that sit on dollar reserves, such as the People's Bank of China, will end up with decreased purchase power over time.
For the US, on the other hand, inflation might be an appropriate means to reduce the real value of its national debt. Since other countries own a lot of this debt, it is a cheap way for the US to deal with its national financial problem.
The scheme devised by Ben Bernanke, head of the US Federal Reserve, of adding dollar liquidity to the market by buying back US$600 billion worth of US government bonds during the first eight months of this year facilitates an increasing level of US inflation.
Professor Arne Jon Isachsen
Ph. D. in Economics from Stanford University. Professor in International Economics at the BI Norwegian Business School Director of Monetary Economics Center of BI Norwegian Business School Previously he has taught BI-Fudan MBA Program and worked with the Ministry of Finance as well as with the Central Bank of Norway. He is currently working on a book on economic and political developments in China.
While more than 90 percent of imports to the US is invoiced in dollars - and an even larger part of exports - only a fraction of China's trade is invoiced in yuan. In order to increase this share, China has in the past couple of years made currency exchange arrangements with a number of countries. The purpose is to facilitate the use of yuan as a currency for invoicing and settlement.
But what should the countries that accumulate a surplus in Chinese yuan do with this surplus? Leave it as a foreign currency reserve in the central bank? That would presuppose that the Chinese government will permit the investment of the funds into financial assets in China.
If a gradual appreciation of the Chinese currency takes place, such reserves would give a good return. In addition there will be a diversification premium.
But as long as the yuan is not fully convertible, the availability of financial assets remains quite limited. This makes the yuan less suitable as a reserve currency in other countries' central banks.
In March 2009, the head of the People's Bank of China Zhou Xiaochuan shared his thoughts concerning the need for a reform of the international monetary system. He maintains that special drawing rights, which the International Monetary Fund at irregular intervals grants its member countries, should replace part of the international role of the US dollar.
The value of SDR is calculated on the basis of a basket consisting of four currencies - US dollars, euros, Japanese yen and British pounds. Currently, SDR stands for seven per cent of the world's total currency reserves.
SDR is almost never used in private transactions. Therefore it lacks liquidity. When SDR is used as settlement in transactions between countries it first has to be converted into a currency.
Or as professor Charles Wyplosz puts it: "SDR can be seen as a store of value waiting to be converted into dollars to be used as a medium of exchange."
The US dollar did not assume its role as the leading international currency by way of deliberate international decisions. Just as one cannot decide that Esperanto will replace English as the leading international language, one cannot decide that the yuan, or special drawing rights in the IMF for that matter, will replace the US dollar as the leading international currency. One might wish for it, but that does not make it come true.
If the dollar is to be dethroned from its position as the leading world currency it has to be through the emergence of better alternatives. Over time the euro might play a larger part. And gradually also the Chinese yuan.
However, it will most likely be a decade or two before the dollar's leading position becomes threatened.
One thing that may weaken the role of the dollar, though, is a persistently high US inflation rate. If such inflation is mixed with relatively low US interest rates, central banks that sit on dollar reserves, such as the People's Bank of China, will end up with decreased purchase power over time.
For the US, on the other hand, inflation might be an appropriate means to reduce the real value of its national debt. Since other countries own a lot of this debt, it is a cheap way for the US to deal with its national financial problem.
The scheme devised by Ben Bernanke, head of the US Federal Reserve, of adding dollar liquidity to the market by buying back US$600 billion worth of US government bonds during the first eight months of this year facilitates an increasing level of US inflation.
Professor Arne Jon Isachsen
Ph. D. in Economics from Stanford University. Professor in International Economics at the BI Norwegian Business School Director of Monetary Economics Center of BI Norwegian Business School Previously he has taught BI-Fudan MBA Program and worked with the Ministry of Finance as well as with the Central Bank of Norway. He is currently working on a book on economic and political developments in China.
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