The people’s currency

By Justina Lee

China is an economic giant, but its money is still a bit of a runt. Unlike the US 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 stability.

The situation

From Oct. 1, the yuan will join four other currencies in the International Monetary Fund’s Special Drawing Rights, a kind of overdraft account it holds for global central banks. It is a milestone that analysts have estimated could trigger a $1 trillion switch into Chinese assets. Yet there’s a long way to go for the currency: China accounts for more than 10 percent of world trade, but less than 2 percent of global payments are made in yuan. 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.

The weaker economy has put downward pressure on the yuan in 2016, prompting China to step up intervention and its central bank governor to make a rare public declaration supporting the currency. China had surprised global markets in August 2015 with its first major devaluation since 1994, prompting speculation that it would further weaken the yuan to support exporters. That speculation has continually tested a pledge by China last year to give market forces a bigger role in determining the exchange rate. The country has burned through foreign reserves and reversed a trend of loosening capital controls in a bid to halt the yuan’s slide and stem capital outflows. 

In potentially its most extreme step, the central bank drafted rules for a tax on foreign exchange transactions. In a bid to become less tied to the US dollar, authorities this year began using a basket of trade partners’ currencies to help determine the yuan’s daily fixing, a move that has made the exchange rate more predictable.

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 US 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. 

The country’s leaders 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. China is also leading the charge to create the first new international development bank in decades. Inside China, the yuan can trade 2 percent above or below a daily fixing set by the government; a freely traded offshore rate tracks it.

The argument

The yuan’s advance into global markets demonstrates President Xi Jinping’s ambition to challenge the hegemony of the dollar and a global economic order dominated by the US and Europe. Inclusion in the IMF’s reserve-currency basket is expected to accelerate the pace of reform. The US, which had scolded China on and off for decades for keeping the exchange rate weak to boost exports, no longer calls the currency “significantly undervalued” and backed its bid for reserve status. 

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 slowdown.

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