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It's the currency, stupid!
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10:50, April 09, 2009

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By Li Hong,People's Daily Online

China has finally decided to move towards using its own currency, the yuan, to settle trade with its neighboring partners, making a maiden but visionary trip to enhance the status of yuan in the global market place.

The State Council, headed by Premier Wen Jiabao, launched the pilot project on April 8, by naming Shanghai, Guangzhou, Shenzhen, Zhuhai and Dongguan to try out the scheme. Though details on how the plan evolves and cascades remain in the pipeline, we have ample confidence that the policy-drawers led by the central bank Governor Zhou Xiaochuan and Trade Minister Chen Deming, who are advised by the country's home-groomed business wizards, will ante up for a neat success.

Whether the move will usher in the yuan to the regional arena as a heavyweight Asian currency is not known yet, but economists have aspired to give the currency a more prominent role in settling border deals, in keeping with China's growing trade prowess as the world's third largest economy.

More creative and ground-breaking ideas are needed in the process to nurture and strengthen the currency, I believe, as the yuan is not freely "convertible" in the market. But reform is never easy, seldom has a tutor, as the past 30 years of the country's modernization has proved that so long we don't deviate from building a cause with Chinese characteristics, it will succeed, this time, too.

Countries and regions that have signed currency swap agreements with Beijing, including Malaysia, South Korea, Argentina, Indonesia, Belarus and Hong Kong, are most likely to try out the yuan settlement. Hopefully more will follow suit.

There are legions of benefits for Beijing to kick off the daring plan. The first, and most probable, intention is to bolster China's trade volume with neighboring partners by shielding traders from the rising risk of major currency exchange rate swings, a phenomenon that is exacerbated by the global financial crisis.

Chinese exporters and importers have complained that their balance sheet is being eaten by an ever-enlarging fluctuations of the exchange rates among the yuan, U.S. dollar, the euro, the yen, and others. The yuan has gained 21 percent against the the U.S. currency since a dollar peg was scrapped in July 2005, eroding the value of exporters' dollar-denominated profits.

And, the swing is not to subdue. The U.S. Federal Reserve's latest decision to purchase US$750 billion mortgage-backed securities and US$300 billion long-term Treasuries, a measure to ease a severe credit crunch and prop up a contracting economy there, sent the value of the greenback tumbling for a few days on the market. Why? Because the paper bills will come out of American printing houses, or created from the "thin air".

China's central government website said in a statement that carrying out yuan settlement in cross-border trade will have "significant meaning" in promoting bilateral trade with neighboring economies. Avoiding a third or middle currency while settling a deal, trade will become smoother, and traders will pick up more profits.

Another benefit of the move, I guess, could be China central bank's intention to wind down U.S. dollar-denominated foreign currency reserve. From any economist's perspective, a 2 trillion dollar hold is too much, even for a large country like China. Premier Wen admitted in mid March at a press conference in Beijing that the government is concerned with the safety of the reserve. A few days later, the Federal Reserve came out with flushing the market with 1 trillion dollars paper money.

Top officials of the Obama administration have shrugged off the idea of Governor Zhou Xiaochuan's brain child of launching a super-sovereign reserve currency, in place of one issued by a specific nation, in an aim to shoot the frequency and intensity of global-level financial crises. Washington claims the greenback remain "very strong" and Zhou’s SDR (special drawing rights) modeled currency is fictional. As the current round of crisis sees no signs of receding, and China's imports and exports slumping by more than 25 percent for the first quarter of 2009, it is better for Zhou and China to do something else, as more dollar proceeds are not desired.

Some U.S. commentators have written that China, with its huge and most dollar-denominated reserve, has driven ourselves into a "dollar trap", which we can neither get ourselves out, nor change the policies that put us in that trap in the first place. Some even claimed Zhou’s advocacy for phasing in world reserve currency showed China's "weakness".

Ironic, hmm… you bet. As the biggest holder of U.S. Treasuries, China is weak?

Since China is believed that it can do nothing with the dollars, but buying U.S. bonds (sorry no high-tech, no security-related assets like the Unocal, and military-usable know-how to Beijing!), won't it be worth trying something else with the yuan?

The article represents the author's view only. It does not represent opinions of People's Daily or People's Daily Online.

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