Yuan Gains Importance as Trade Currency

By Valentin Schmid, Epoch Times
March 24, 2015 7:15 pm Last Updated: April 17, 2015 10:09 pm

Trade is good for everybody, at least according to economic theory.

While it doesn’t constitute the biggest part of GDP (in 2014, the total U.S. trade volume was only 25 percent of GDP), it has huge effects on the rest of the economy.

Many jobs depend on the export and import sector and some products could not be made without parts being imported from abroad.

Of course, things look different in practice, as trading parties want to gain advantages over the others by using underhanded means. Every country engages in these practices to a certain extent, but China has been known for manipulating its currency as well as subsidizing certain industries, which then dump their products on foreign markets to wipe out competition (solar!).

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So from a macro point of view, unlimited and unfair trade with China is not good for everybody, maybe not even China itself. However, from a micro point of view, an importer of Chinese products or an exporter to China just wants to make money.

So for an individual firm trading with China, reducing the cost of trade is beneficial. As a result, the increasing liberalization of trade in the Chinese renminbi is viewed as a positive by companies from small to large.

(HSBC)
(HSBC)

“As the opportunity to do business with China increases, U.S. businesses can take advantage of using renminbi (yuan) to deepen relationships with suppliers, reach new suppliers, or reduce their exposure to currency fluctuations,” said Kevin Quinn, head of Corporate Banking for HSBC in upstate New York. “The benefits of using renminbi to settle trade with the world’s biggest trading nation and the second largest trading partner of the U.S., behind Canada, can’t be overlooked.”

According to a new HSBC survey, only 10 percent of U.S. companies currently use renminbi to settle trade at this moment, but 20 percent are thinking about using it in the future.

Cost Savings

The survey showed that businesses on either side of the trade can save money if they are able to freely transact in yuan, something they haven’t been allowed to recently.

As of this moment, most U.S. businesses importing from China are paying their supplier in dollars. They pay higher prices because they have to file the trade documents with their banks to get yuan for dollars. This process takes time and is therefore risky, because the dollar might go down in value. As a result, the supplier passes these costs on to the importer.

Many jobs depend on the export and import sector.

“If you are an importer and you are paying in U.S. dollars, it is a well-known practice that your counterpart in the mainland is accepting the risk. As part of accepting the risk, there will be a premium charged on top of the price of your goods” said Debra Lodge, head of HSBC’s renminbi business development in North America.

This is part of China’s capital controls, which are supposed to prevent people from moving money outside the country, and has nothing to do with trade in goods or services.

In liberalized markets like the euro and the dollar, companies can just open accounts with commercial banks in Europe and buy euros on the open market. They can then pay their suppliers in euros at a lower price.

(HSBC)
(HSBC)

China is moving to that direction with the offshore renminbi market, which started in Hong Kong. A foreign company can open a bank account denominated in renminbi with a designated bank located in Hong Kong. It can then use this deposit to pay for imports by transferring it to the bank account of an exporter, even inside China. Unlike with a transaction in dollars or  euros, however, the supplier doesn’t take any currency risk and can send in the trade documents electronically, which saves time.

Apart from the offshore market in Hong Kong, China is further moving toward liberalization by setting up clearing banks in Europe, Asia, and the United States. These banks can directly settle trade in these countries by bypassing the U.S. dollar.

Further cost savings are available through a host of hedging products in the offshore renminbi market and liquidity is improving rapidly. 

“China continues to establish reforms to reduce financial and bureaucratic barriers to using the renminbi and decision makers are increasingly anticipating its wider use in international transactions over the longer term,” said Quinn.

No Reserve Currency

However, increasing the use of Chinese yuan as a trade currency doesn’t mean it will displace the dollar as the world’s reserve currency.

The world’s reserve currency is the go-to currency when it comes to investing the wealth accumulated through trade—a piggy bank for rainy days.

Central banks are extremely conservative investors. They want to preserve value and be able to sell their assets rapidly, in case of an emergency.

Because of U.S. military and economic strength, central banks are generally happy investing in U.S. Treasurys—the principle reason why the U.S. Treasury market is the deepest and most liquid in the world.

China is different. The investment opportunities in China are often risky (bank deposits), illiquid (infrastructure), or both (real estate), and don’t qualify as central bank investments. The regime bond market is so small that it would not be able to hold the reserves of even a single medium sized country.

Most crucially, however, world-class financial markets rely on a set of domestic institutions independent of capricious regime meddling, and investors demand the rule of law. The United States, despite whatever it has done to undercut trust in its own institutions, is still eons ahead of the People’s Republic of China when it comes to independent regulation, a court system with integrity, and transparency.