Pay Us In Yuan, Not Dollars (Pretty Please)

An interesting piece in the FT by StanChart's chief economist Gerard Lyons makes the case that, in spite of its continued willingness to buy dollar-denominated reserve assets, China is nonetheless undermining the dollar by facilitating the use of renminbi swaps with its trading partners for invoicing and settling transactions. For sure, there is still some way to go before the yuan becomes more freely traded, but this is a step in the right direction.

I cannot possibly hide my antipathy towards the wretched greenback, so I wish these small-scale experiments China is conducting with various LDCs--especially those in Southeast Asia--pick up speed. What impresses me with Lyons is that, unlike many other commentators who've been living in their whitebread world (as Billy Joel once sang), he understands that these efforts are currently being coursed through the Hong Kong Monetary Authority (HKMA) and not the People's Bank of China (PBoC). The reason is simple: the former simply has more accumulated experience facilitating these types of transactions. The currency is the yuan, but the overseer is a former British colony's legacy central bank:

There is a ticking time bomb under the dollar. When it explodes depends not just on the US economy but also on policy actions in Beijing and Washington. Over the last year the Chinese have undermined the dollar by the back-door, questioning it as a store of value and medium-of-exchange.

Although the Chinese are not advocating the renminbi as the alternative to the dollar this may be only a matter of time. One needs to focus on what the Chinese do, as well as listen to what they say. A key development is China’s encouragement of international use of the renminbi, although they prefer to call it invoicing.

This may be from a low starting point but one Chinese saying may be worth bearing in mind: “A march of 10,000 miles begins with one small step”. Early signs are promising. China is encouraging exporters to invoice in the renminbi and is setting up systems to allow trade payments in renminbi. This make sense. China’s trade is soaring. New trade corridors may soon require new means of payment. When the Chinese and Brazilian Presidents met last year they agreed to use their own currencies to settle more of their bilateral trade, rather than invoicing in dollars. Although viewed as symbolic, it is a sign of things to come.

The crisis also saw China sign a host of bilateral currency swap agreements with countries ranging from Indonesia to Belarus and Argentina. China’s growing trade and financial links with the rest of the world will make the renminbi more acceptable. Gradualism dictates the Chinese approach to most policy measures. The process is logical. Look at the theory, examine the pros and cons, debate the issue, implement slowly and observe. If the project works, roll it out. On that basis, there is more to come.

Since a pilot programme started in July 2009 the volume of international trade settled in the Chinese currency has totalled Rmb11.6bn ($1.7bn). Although only 0.1 per cent of Chinese trade in that time, it has gathered momentum. This has encouraged the authorities to expand the programme.

Renminbi invoicing has been restricted to 400 mainland companies in five cities: Shanghai, Shenzhen, Guangzhou, Dongguan and Zhuhai. It will soon widen to cover thousands of mainland companies and more provinces, including Heilongjiang in northeast China which has sought approval to settle trade with Russia in renminbi. These are still early days and China will need to clear a few technical hurdles to make the renminbi widely acceptable. For instance, guidelines for invoicing and settling trade in renminbi need to be harmonised.

Hong Kong is the main beneficiary as the renminbi gains acceptance abroad. It has the natural advantage of a renminbi deposit base, well-established trade links with China and a head-start in developing renminbi financial products. The city’s regulators are ensuring it retains its edge.

Since February, the Hong Kong Monetary Authority has made it easier for its banks to process trade transactions in renminbi, to develop renminbi based financial products such as bonds, and to extend loans to and take deposits from local companies in renminbi. In January, China implemented a free-trade agreement with ASEAN, the Southeast Asian grouping of 10 countries. Rising Chinese trade with the rest of Asia will boost renminbi settlement in Hong Kong.

There will be future tipping points. Convertibility of the renminbi on both trade and capital accounts would be the ultimate hurdle to cross for China to make its currency globally acceptable. This will eventually happen. China also needs to develop its capital markets and financial infrastructure.

As international reserves soar I detect among reserve managers a desire to shift away from the dollar. Yet they do not want to actively sell the dollar, lest it triggers the crisis they fear. Instead fewer net new reserves are being placed in the dollar. I call this passive diversification but until the renminbi becomes convertible it is unlikely to take its rightful place in reserve holdings.

International use of the renminbi will also rise as Chinese firms invest overseas and its government increases support to other countries. This is already happening. For instance, China recently signed a $20bn financing deal with Venezuela, half to be paid in renminbi.

Furthermore, renminbi use has increased despite the currency’s peg to the dollar. Once the renminbi starts to appreciate it may receive an additional boost as a store of value. This de-pegging of the renminbi to the dollar could occur soon, but it is more likely to be a gradual and ongoing shift than a big one-off move. It would signal a trend appreciation of the renminbi. “Made in China”, the three most common words of the last decade, may soon be joined by “Paid in renminbi”.

It gives a whole new meaning to one country, two systems, eh? Weaning the world off "dollar hegemony" is long overdue. Given its history of economic gradualism, these are heady times for China. The dollar is the currency of the past slowly sinking in the quicksand of subprime globalization and not the future. Let China show us the way.