Global transaction services organization SWIFT announced in July that the yuan had become the world’s seventh-most-used currency for payments. The six other most used currencies in order are the US dollar, euro, British pound, yen, Canadian dollar and Australian dollar. It is no surprise that the US dollar is still the most used currency, with its distinguished status and unique advantages. As the biggest economy and largest market for end products in the world, the domination of the US dollar is expected to continue for years to come.
The yuan is the fastest-growing currency in terms of trade settlement, but it is very unlikely that the yuan would replace or challenge the US dollar this century. According to a recent report by the Bank for International Settlement (BIS), the US dollar is used 40 times more than the yuan for business transactions worldwide. In that case, why has yuan internationalization been such an issue for a long time? Why are the relative merits of the US dollar and the yuan always debated?
To make a long story short, the world is not happy with US “misconduct.”
The series of US quantitative easing measures launched in November 2008 and planned to end in October this year have long been criticized as “beggar-thy-neighbor” policies.
On top of that, the policies have been adopted by the US Federal Reserve to cope with the negative effects and consequences of the global financial crisis that was triggered when the US subprime mortgage housing bubble burst.
Disappointed at the US’ economic performance, the world deliberately put China on the spot.
China became the world’s biggest exporter in 2009, surpassing Germany, and the second-largest economy in 2010, bypassing Japan.
It is therefore sensible that people have high hopes for China’s role in the global economy and thus believe it is time for the yuan to become an international currency.
However, currency liberalization is a necessary condition for currency internationalization. As China still maintains extremely tight control over its capital account, yuan internationalization has a long way to go.
The Triffin paradox demonstrates that if a nation’s currency is the international currency, the nation must be capable of supplying an excess of its currency to meet global demand. That means that the country has to run a current account deficit. The US and the US dollar are a case in point.
China, on the other hand, has long enjoyed a trade surplus — in contrast to developed economies like the US and Europe. Many must have serious doubts that China is willing to let go its surplus to internationalize the yuan. Besides, without its advantageous exporting status, China is probably unable to meet its annual growth target of 7.5 percent.
Furthermore, using a particular currency is a hard habit to break. As global trade has long been carried out in US dollars, it would take a major and unanimously agreed structural change for other currencies to replace it.
A Canadian trade and finance expert paid me a visit in mid-September this year and told me that a Canadian trading company proposed using the yuan when doing business with its Chinese counterpart. Surprisingly, the Chinese rejected the proposal and insisted on using the US dollar for bilateral trade, even though using the yuan would reduce some costs.
In theory, an international currency must meet three criteria when it is used across borders: It must serve as a medium of exchange, a unit of account and a store of value. In other words, an international currency must be useful for settlement, invoicing and reserve all at once. The yuan has been gradually meeting those criteria.
Apart from the Canadian example, Chinese companies have been trading with neighboring economies, mostly Asian, in yuan. Several central banks, including the Central Bank of the Republic of China have added the yuan to their foreign exchange reserves portfolios and might gradually increase the yuan ratio in reserves, given its propensity to appreciate in the future.
In addition, major central banks, such as the Bank of England and European Central Bank, signed bilateral currency swap agreements with the People’s Bank of China (PBOC). Since December 2008, the PBOC has signed swap agreements with 25 central banks that could enhance global acceptance of the yuan.
Yuan internationalization is not a goal that can be fulfilled overnight, but it looks to be an inevitable trend at a slow — but sure — pace.
China is Taiwan’s No. 1 export destination, accounting for 40 percent of Taiwan’s total exports. Since last year, China has also become Taiwan’s biggest origin of imports, accounting for between 16 and 17 percent of total annual imports. The central bank has expressed an interest in signing a cross-strait currency swap agreement with the PBOC and the government has also indirectly approached Beijing about raising the Renminbi Qualified Foreign Institutional Investor quota in the hopes of expanding Taiwan’s offshore yuan business.
Some have even suggested that Taiwan ought to cooperate with the Shanghai free-trade zone and acquire these financial benefits as soon as possible.
There are indeed certain advantages for Taiwanese businesses with respect to the yuan’s internationalization. The transaction costs would be further reduced if cross-strait trade could be settled in yuan, and there would be more opportunities for Taiwanese to work with Chinese businesses. On top of that, there is also a chance of Taiwan developing into an offshore yuan financial center.
However, Taiwan must be aware of the potential challenges and risks.
China tried to localize its supply value chains even before the global financial crisis. As a result, the status of cross-strait trade relations has turned from complementary to competitive.
The rate of increase of Taiwan’s exports to China stood at 115 percent in 2002 and 118 percent in 2003. The rate dropped to 59 percent in 2004 and further declined to 20 percent in 2005. The period before the financial crisis was the first phase of China’s supply-chain localization. In the post-crisis era, to deal with the shrinking demand from the world market, China launched its second phase of localization policies.
These policies have had a serious impact on Taiwan’s exports, as the nation’s economy has been relying on exporting intermediate goods to China.
Once China makes further progress toward yuan internationalization, its industries will become even more competitive. Chinese businesses could then save transactional costs by lowering foreign-exchange risks, providing better offers and discounts when competing with Taiwanese businesses, and acquiring advanced technology at lower costs, alongside other benefits.
In the long run, the challenge for Taiwan is to get tougher when dealing with yuan internationalization.
It is critical for Taiwan to seriously and carefully position itself for any potential impact in addition to gawking at the potential benefits of the yuan’s potential future status.
Darson Chiu is the deputy director of the Macroeconomic Forecasting Center at the Taiwan Institute of Economic Research.
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