Chinese policy makers are moving toward the internationalization of the yuan, amid growing worries about the country's exposure to the fiscal woes of the United States and the U.S. dollar's role as the global reserve currency.
Li Daokui, an adviser to the People's Bank of China, told The Globe and Mail that he believes the yuan - which is currently in circulation only in China and a handful of neighbouring countries under special agreements - will be a fully international currency within five to 10 years.
China, he said, has two goals in moving to increase the international use of the yuan, which is also known as the renminbi. The first would be to decrease the country's reliance on the U.S. dollar, which he suggested should no longer be considered a safe haven following the near-collapse of the American financial system in 2008. The second goal would be to stabilize the international financial system by creating another major currency where investors could put their money in times of crisis.
"China definitely wants, as all countries do, the ability to fend off external volatility, external shocks," Mr. Li said in an interview at the offices of Tsinghua University's Centre for China in the World Economy, where he is director. "A three-currency world is much more stable than a two-currency world. People can choose; if they think the U.S. dollar is safe, they can put their money in U.S. dollars. If the renminbi is safe, they can put their money in renminbi. Or you can put half and half. If one country doesn't behave in its macroeconomic policy, its currency will come down."
Just as important to many Chinese is the sense that making the yuan into a major international currency is the next step in confirming the country's new status as an economic and diplomatic power.
But a world in which the yuan is a major trading currency would necessarily look quite different from the one dominated by the U.S. dollar, forcing both the United States and China to confront the imbalances in their domestic economies.
Few expect Beijing to promote the yuan as an international currency without moving some of its own reserves away from the dollar. And it seems even more unlikely that money markets could be convinced to trust the yuan without Chinese authorities first loosening their tight control over its value.
Mr. Li's comments hinted that many in Beijing are uncomfortable with the country leaving so much - $1.14-trillion (U.S.) - of its foreign exchange reserves in the U.S. dollar.
"It's ironic, isn't it? The U.S. is the epicentre of the global financial crisis, but the U.S. dollar is the monetary safe haven. The country is having much more financial trouble than China, or even Russia, but we put our money there," he said. "By having an international currency, China is helping itself by helping the world."
His comments matched a recent report issued by HSBC bank which predicted the yuan would join the dollar and euro as one of the main international settlement currencies some time later this year.
Mr. Li acknowledged that there were several major hurdles to the yuan taking its place alongside the dollar and the euro as a global force. The next step for China will be to promote the use of the yuan in international trade settlements, something that's already on the rise. Rattled by the financial crisis, Beijing has signed currency swap deals with 11 countries - most of them in Asia - since 2008. The deals allow for trade between the countries to be conducted in yuan, rather than dollars.
The second thrust is to increase the use of the yuan in international finance, something also on the increase with the rising popularity of yuan-denominated "dim sum" bonds issued in Hong Kong, with companies like McDonald's Corp., HSBC and the Asian Development Bank issuing yuan-denominated debt for the first time.
In the first quarter of 2011, 7 per cent of China's total trade was settled in yuan. Meanwhile yuan deposits in the Hong Kong banking system had risen to almost $80-billion by the end of April, up ninefold since July, 2009.
The big question facing Chinese policy makers is how to accomplish the internationalization of the yuan without giving up their cherished control over its value. An artificially cheap yuan has been one of the biggest drivers of China's export-led boom over the past two decades, a model that won't be lightly tinkered with. Just as crucially, since Chinese citizens can't easily convert their yuan or send their savings overseas, banks here have been able to offer them low interest rates, benefiting big business and helping to fuel a surge in investment in domestic real estate and other markets.
Though the yuan has been allowed to gradually appreciate in recent months toward something closer to its real value, there is also concern that space could develop between the currency's official level, as set by Beijing, and what it trades for in Hong Kong and elsewhere.
"There's no reason, over time, why the renminbi won't become a fully international currency, but it won't become a reserve currency until it becomes a fully convertible currency," said Ken Courtis, former vice-chair of Goldman Sachs Asia and founding partner of Hong Kong-based Themes Investment Management. Mr. Courtis said the United States "would not be excited" by China's moves to internationalize the yuan since it would likely mean Beijing would seek to diminish its holdings of U.S. debt.
In an article published this week in the official China Daily newspaper, Yu Yongding, president of the China Society of World Economics, called the internationalization of the yuan "necessary and indeed inevitable." However, he warned the road ahead was filled with risks for China's economy.
"To get the sequence of policy adjustments right is vital. The RMB's path to becoming a truly international currency promises to be a bumpy one."