China's Foreign Exchange Trade System announced yesterday that direct trading of the yuan against the Japanese yen will start on June 1, a step widely regarded as an important one for the internationalization of the Chinese currency. It is the first direct trade between yuan and a non-US dollar currency.
China's economic clout is close to half of the US'. It is generally expected to reach the US' economic size in around two decades. However, the real distance between the two economies is wider than the number suggests. China not only lags behind in innovation, core technology and brands, it is also dangerously weak in financial competitiveness.
For example, the Chinese yuan is still basically a domestic currency circulated within China. It can be exchanged into local currencies in some countries, and it can be spent directly in a few neighboring countries, but those are primitive applications. Yuan trades into any other currency have to be exercised through the US dollar. This brings huge risks.
Yuan globalization also has its risks, but its necessity has long been accepted, and it is now a question of what form and pace this globalization should take. Trade settlements in yuan started in July 2009. The trade volume settled in the Chinese currency reached 2.58 trillion yuan last year, 10 percent of the total. The proportion will reach 15 percent this year, greatly avoiding the risk brought by fluctuation in the US dollar.
Direct trade into the yen is another step forward. Later, China needs to carry out yuan direct trade with other major currencies, such as the euro and British pound, with risks being kept under control, to build global credibility for the renminbi.
The greenback accounts for 60 percent of global exchange reserves, a huge benefit for Washington. Once the Chinese yuan becomes part of the reserve currency, the US will feel an impact on its interests. But don't expect it to be a smooth experience.
For example, China needs to implement a more active monetary policy, and not simply respond to the US' moves.
It will take a long time for the Chinese yuan to grow into a global currency. The result and the process will significantly alter China's economic environment. Given the widespread lack of financial knowledge, financial regulators face a daunting challenge in communicating with the public over issues such as trade balance and foreign aid. It requests strong policymaking ability.
The globalization of the yen coincided with Japan's economic recession. The Chinese yuan is supported by better economic prospects and more stable politics, which means the yuan should have better luck.
