China’s march to currency dominance just got longer

March 1, 2012

By John Foley

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

China’s path to currency dominance just got a bit longer. Hong Kong holdings of the Chinese yuan fell in January, according to data out on March 1; there has been an 8 percent decline since the end of November. With the yuan no longer certain to rise in value, foreigners have much less reason to hold it. For a would-be reserve currency, that’s a real spanner in the works.

When the yuan looked undervalued, everyone wanted it. As China started letting yuan flow more freely over the border into Hong Kong in 2010, financial osmosis took place. Individuals took up their daily allowance of the currency, suppliers to Chinese companies asked to be paid in it, and for those too impatient to wait for gradual appreciation, the higher offshore exchange rate offered a quick profit.

New channels for buying yuan keep opening, and there’s talk of new trading hubs in cities like London. But it’s now hard to see why anyone would rush to use them. The yuan’s value looks about right. With the economy slowing, there is little to drive it up strongly. And the yuan isn’t ready to be a reserve currency, because China lacks the requisites: stable inflation, transparent policymaking and free convertibility.

Indeed, yuan deposits in Hong Kong, which had doubled in the year to last November, may well keep falling. Chinese banks, who raised funds offshore, are spiriting the money back home to shore up their balance sheets. Companies also seem to be bringing yuan home, to judge from the unexplained spike in trade-related flows in December. And yuan deposits in Hong Kong still yield a measly 0.5 percent, compared with the three-month mainland rate of 3.1 percent.

While yuan deposits were ballooning, Beijing seemed to have found a way to bypass the need for offering investors full currency convertability, by offering the prospect of fat appreciation profits instead. Even without those profits, China will get a global currency one day, but there are no short cuts when it comes to dethroning the U.S. dollar.

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