News Analysis
Beijing wants the yuan to be truly global, but this will be impossible unless the Chinese Communist Party (CCP) releases its capital controls and allows the currency’s value to be set by the markets.
Even then, the dollar will most likely continue to be the world’s currency.
Over the past two months, the yuan has taken a number of steps toward internationalization with the release of the digital yuan, Russia’s use of the yuan, possible yuan-denominated oil trade with Saudi Arabia, and discussions of yuan foreign currency reserves in other countries.
Many speculate that the internationalization of the yuan may be accelerated by the CCP stepping in to help Russia bypass international sanctions. However, the issue is that while China wants its currency to be widely used, such as the dollar or the euro, the central government doesn’t want to allow the currency to move freely across its border, nor allow the exchange rate to be completely dictated by the open market.
With the current system, the CCP can regulate the volume of yuan flowing in and out of the country, and the value of the yuan is largely influenced by the central bank.
China’s yuan internationalization dilemma is a classic example of what economists call the impossible trinity. Essentially, it’s impossible for a central government to have three things at the same time: a stable currency, the free movement of capital, and independent monetary policy. In order for the yuan to be internationalized, Beijing would have to let go of at least one of these restrictions, something it has never seemed to want to do.
A woman walks past the headquarters of China's central bank in Beijing, on Feb. 3, 2020. Jason Lee/Reuters
In order for the yuan to replace the U.S. dollar as the world’s global currency, the yuan would need to be fully convertible. Currently, the yuan is only to be considered partially convertible. To achieve full convertibility, the yuan would have to be exposed to market forces, which would require significant economic liberalization and an overhaul of China’s financial system.
If Beijing wants other countries to hold the yuan as a reserve currency, the quantity of yuan abroad would have to increase. This could only be achieved by releasing government controls on capital flows. If these steps are taken, Beijing may find itself facing currency overvaluation, something it has fought to stave off for decades. Historically, the CCP wanted to suppress the value of the yuan in order to keep Chinese labor inexpensive and make Chinese exports more attractive in foreign markets.
Currently, the dollar accounts for 60 percent of world foreign currency reserves, with foreign banks holding $950 billion in U.S. cash and $7.55 trillion in U.S. Treasury notes. As the yuan is used in less than 2 percent of global trade settlements and makes up only 2.5 percent of foreign currency reserves, the quantity of yuan available on world markets would have to increase by nearly 30 times to replace the dollar.
When China joined the World Trade Organization, it promised to liberalize its exchange rules. But given the central bank’s hyperactive financial intervention and regulation over the past two years, Beijing doesn’t appear to be ready to relinquish control. Historically, the CCP has seen capital controls as crucial to its economic development.
By regulating the value of the yuan, China has been able to keep its exports cheap, promoting export-led growth. Consequently, companies, financial institutions, and individuals in China must abide by the CCP’s “closed” capital account policy, which prevents money from freely moving into other countries.
Foreign exchange is overseen by the State Administration of Foreign Exchange (SAFE) and the People’s Bank of China (PBOC). SAFE is responsible for setting relevant regulations and administering China’s foreign exchange reserves. Its approval is also needed for outbound forex payments.
Apart from SAFE, outbound investments must be reviewed by three other agencies, including the National Development and Reform Commission, the Ministry of Commerce, and the PBOC.
If a company fails to comply with SAFE requirements, its capital account can be taken over by the foreign exchange bureaus, and banks will refuse to process the company’s foreign exchange business. The banks will also prevent the company from distributing profits to foreign shareholders. This means that there are restrictions on overseas transfers, cross-border trade financing, and cross-border investment financing.
Even if the CCP enacts the structural changes necessary for the internationalization of the yuan, the dollar is still likely to remain the world’s reserve currency for many years to come. Before selecting a currency to invest in, a central bank looks at several parameters.
First, it looks at the chance of the borrower defaulting. The U.S. government has never defaulted on a debt, making the risk of U.S. Treasury notes effectively zero.
Next, a banker wants to know if the income derived from the investment could lose value as a result of the currency depreciating. A recent example of this type of currency risk would be ruble-denominated investments. Even with a 20 percent interest rate, ruble investments would still be at a loss because the currency has lost more than 30 percent of its value since the Russian invasion of Ukraine. With the dollar, there’s very little chance of this type of sharp decline in value.
Finally, a banker needs to know if the investment could be easily sold or converted to cash. U.S. government debt is considered to be nearly as liquid as cash, as there’s a tremendous market where U.S. Treasury notes can be instantly sold in any quantity. On average, more than $500 billion worth of Treasurys are bought and sold each day.
Views expressed in this article are opinions of the author and do not necessarily reflect the views of The Epoch Times.
