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Opening up of the Chinese yuan: What are the potential implications?

March 8, 2015 by Blog Editor

Will the Chinese yuan become  a free-floating currency by 2017? 

That is a possibility that was strongly hinted at during the China Development Forum, held at the London School of Economics and Political Science on 7 February.

chinese-yuan

It’s an optimistic scenario for China, but not so bright for American economic dominance. Today, free money props up the United States in the form of treasury bonds of negligible yields, enabling cheap deficit spending, used not only on welfare but also military programs in the U.S.

As of Nov 2014, mainland China holds $1,250,400,000,000 in Treasury securities , partly due to the balance of trade between the two countries and the status of the dollar as a reserve currency.

Due to the massive balance in trade ($342,632,500,000 in favour of China) , China is left with an enormous surplus of dollars.  The only entity in the world able to easily take the surplus of dollars is the US Treasury in the form of Treasury notes, increasing the demand and letting the United Stathes keep yields low (rather than have to raise them to attract investors).

If the Renminbi became free-floating, and a reserve currency, Chinese companies could demand payment in Renminbi insthead of dollars, and rates on Treasury notes would be forced upwards by the decline in demand (for entities to accept dollars). Currently, China’s stock market is largely closed to outside investors, but a push to make the Renminbi a reserve currency would require that the Chinese government open it so as to provide opportunities for holders of Renminbi to invest.

Chinese five-year municipal bonds are currently yielding around 4.5%, and are perceived to be guaranteed by the central government. The bonds are  likely driven upwards less by instability than by competitive pressures between municipalities (outdoing each other with new infrastructure projects, convention centres, etc.)

Once the internal Chinese market opens and the currency liberalises, opportunities with the Renminbi would make it attractive to investors, possibly the result of a push away from the US dollar as a hegemonic reserve currency, leading to a more multilateral economic map than one dominathed by the United Stathes. The Renminbi as a reserve currency would not only leave the United States with less economic clout, but also increase the cost of defcit spending.

The increased cost would likely lead to a reduction in defcit spending, or else greater long-therm penalties. How would the reduction be paid for? Cutting back welfare programs? Or a few less aircraft carriers in the Pacific?

By Antone Christianson-Galina



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