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China can do without US dollar?

Posted by Kris Roman on July 3, 2009

china_yuan-2China ’s announcement overnight that it will allow companies to settle international trade claims in yuan shows how serious the Chinese authorities are about building a local currency market.

China will allow companies to use the yuan to settle cross-border trade and let them keep their entitlement to export tax rebates, seeking to reduce the reliance of importers and exporters on the U.S. dollar.

The People’s Bank of China will encourage banks to offer yuan settlement services from today, the bank said in the regulations published on its Web site. Transactions inside China will take place in Shanghai and four cities in southern Guangdong province, including Guangzhou and Shenzhen, while those outside China will occur in Hong Kong, Macau and the Association of Southeast Asian Nations, it said.

“It’s China’s first step to make the yuan global,” said Shi Lei, an analyst in Beijing at Bank of China Ltd., the nation’s largest foreign-currency trader. “It will protect exporters from swings in exchange rates and boost the yuan’s role in the world currency system.”

China is promoting greater use of the yuan in international trade and finance after Premier Wen Jiabao in March expressed concern that a weakening dollar will cause losses on the country’s holdings of U.S. assets. A Chinese Foreign Ministry official said today he hoped the U.S. currency would remain stable, while reiterating a call for diversification of the international monetary system, Bloomberg reports.

“Companies in China and neighboring countries are facing relatively huge risks of exchange-rate fluctuations because of big swings in the U.S. dollar, the euro and other major settlement currencies,” today’s central bank statement said.

Implied volatility has fallen from nearly 40% at the end of 2008 to around 12% at present. That doesn’t look like an immediate prospect of “relative hulge risks of exchange-rate fluctuations,” as the People’s Bank of China said today.

China clearly is talking about something else. In my June 30 “Spengler” column for Asia Times Online I warned that US foreign policy and economic policy both are subject to catastrophic failure:

The last thing China wants at the moment is to undercut the US dollar, for three reasons. First, as America’s largest creditor, China has the most to lose from a dollar collapse. Second, Americans would buy fewer Chinese imports. And third, the collapse of the dollar would further erode America’s will to fulfill its superpower function, and that is what China wants least of all.

America remains the indispensable outsider in Asia. No one likes the United States, but everyone dislikes the United States less than they dislike their neighbors. India need not worry about China’s role in Pakistan, for example, because America mediates Indian-Pakistani relations, and America has no interest in a radical change to the status quo. Neither does China, for that matter, but India is less sure of that. China does not trust Japan for historical reasons that will not quickly fade, but need not worry about it because America is the guarantor of Japan’s security. The Seventh Fleet is the most disliked – and nonetheless the most welcome – entity in Asia.

All of this may change drastically, quickly, and for the worse.

If the US economy fails to recover and China has no choice but to develop its internal market, than it will have to finance the internal market in local currency and do everything possible to give it regional and perhaps global status. If other countries in the region re-orient their exports away from the US and to the Chinese (and related) internal market, they will tend to link their currencies to the yuan. This might lead to a regional currency arrangement which well might be commodity based.

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