The Future of China's Yuan

Currency may eventually join the dollar and euro on the global stage.

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With the value of the U.S. dollar continuing to fall and no apparent bottom in sight, some currency experts have begun to wonder whether the greenback will remain the international currency of choice. Some experts look at China's economic rise and see its yuan as a future global currency competitor. But at a monetary policy conference in Washington held yesterday at the Cato Institute, a libertarian think tank, experts on Asian finance made clear that China has a long way to go before the yuan can become an international currency. The transition, said Eddie Yue, deputy chief executive of the Hong Kong Monetary Authority, will be "more like the gentle flow of a river than the big waves of the ocean," because China has much work to do to liberalize its capital markets.

So how tightly does the People's Bank control the currency? The yuan has been appreciating vs. the dollar since the People's Bank of China lifted its policy of strictly pegging the currency to the greenback in 2005. John Greenwood, chief economist at London's Invesco, explained that despite the loosening of the peg, China's trade surplus has continued to grow. This is due in part, he said, to the significant steps the bank takes to reduce the value of the currency. Politicians and pundits in America have long complained that the supposedly undervalued yuan has resulted in unfair economic competition from undervalued Chinese-manufactured goods flooding American markets. But what's not often talked about is the effect on China's economy. Greenwood said that the effect of the bank's intervention has been the overexpansion of China's export sector at the expense of domestic industries like healthcare and construction. "The undervaluation of the currency sends the wrong signal to the economy," he said.

But that doesn't mean that China isn't trying to take the steps necessary to make the yuan a freely traded currency. Fred Hu, the managing director of Goldman Sachs Asia, predicted that it's "just a matter of time" before the yuan goes global. "By 2020, the [yuan] will be a major reserve currency," he predicted.