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Is The Yuan Ready For Prime Time?

 April 24, 2012 09:32 PM


(By Jack) Many commentators who follow the global markets were very excited on the recent announcement that China would "widen the trade band" for its currency.

The People's Bank of China, China's central bank, said it would allow the yuan to trade up to 1 percent on either side of a midpoint price it sets every trading day. Previously the currency was allowed to fluctuate 0.5 percent.

Some were so overwhelmed, they pronounced this must be proof positive China is not headed for a hard economic landing, and soon its currency will be replacing the dollar as global reserve currency. That is a bit of hyperbole, to say the least.

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If the Chinese currency is going to lift the Chinese economy out of trouble, it will take a lot more than a 1 percent change in the trading band. The country requires a major restructuring of its growth model, to which its currency is only one component; albeit a very important one. The belief that this move is a reflection of the fact the yuan will displace the dollar in the near future seems farcical.

China's Desire for World Status

I don't think there is any doubt that China would someday love to attain world reserve currency status with the yuan. And indeed, they have taken some minor steps in the process of internationalizing their currency.

For example, China has established currency swap arrangements with some of its key trading partners, so both countries can bypass the U.S. dollar. It has also allowed a Chinese yuan Hong Kong deposit to be created; it trades freely in Hong Kong. And then there is the widened trading band, which I discussed at the beginning.

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These actions, plus their general disgust with being locked into the U.S. dollar reserve system (the U.S. Treasury/Federal Reserve implicit weaker dollar policy means China must pay more for imported commodities as most currencies are priced in dollars), means China would jump at the chance to have an alternative.

Given the dismal status of the global monetary system, China isn't the only one unhappy with the U.S. dollar as the global reserve currency. But if history is any guide, shifts in the global monetary system take much longer than we expect …

One reason is because they are haphazard. Changes in global monetary status morph, or at least it has been that way historically. All we have to do is watch the G-20 to see how difficult serious, multi-global planning can be …

The handoff from pound Sterling to the U.S. dollar was an unplanned evolving event that accelerated after WWI.

And there was no great planning when President Richard Nixon took us off the gold standard, which ushered in the error of floating rate currencies. The gold was draining out of Fort Knox, something had to be done. Game over. Dirty float for a couple of years, then no pretense whatsoever of anything backing the currencies of the world's major powers.


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