US Presidential Elections: Yuan Emerges as Real Alternative to US Dollar

The yuan has been in the news for all the wrong reasons - Mitt Romney's claim that the currency is being deliberately kept at a high value against the US dollar - and all the right reasons - the fact that it has increasingly become the currency of choice for trade among Southeast Asian countries.

The yuan, or renminbi (RMB), climbed to a 19-year high of 6.238 against the US dollar on 26 October. Analysts and the forex market tried to attribute the rate to the legal action against Bo Xilai, the tainted ex-politburo member of the Chinese Communist party, and to China's leadership transition.

With the emergence of China as a regional leader, its currency has begun to play a key role as a regional benchmarking currency in southeast Asia, replacing the US dollar and euro.

Phathanaphong Phusuwan, a senior Bank of Thailand official, said at a seminar on Thai-Chinese trade in August that the yuan was likely to be used as a reference currency between China and Asean (Association of South East Asian Nations) members in the long-run.

Thailand is China's second largest trading partner in the Asean block with a contribution of $64.7bn in 2011 - 22.3 percent up from the previous year.

"In the long run from 2015 onwards, trade with Asia will largely increase under the Asean-China Free Trade Area agreement, which will influence the use of the yuan and local currencies. The yuan is then a good alternative for international trade in the future," Phusuwan told Xinhua news agency.

Since June 2010 when many RMB currency restrictions were eased, the number of regional currencies tracking the currency has increased, said Arvind Subramanian and Martin Kessler.

Historic development

"Over the same period, the number [of currencies] tracking the euro and the dollar declined," the researchers, who work at the Washington-based Peterson Institute for International Economics (PIIE), told the Financial Times. According to them, the region already has a renminbi bloc and seven out of 10 currencies in the region run parallel with the renminbi rather than with the dollar. This, they said, was an "historic development".

"The currencies of South Korea, Indonesia, Malaysia, the Philippines, Taiwan, Singapore, and Thailand more closely track the RMB than the dollar. The dollar's dominance as reference currency in east Asia is now limited to Hong Kong, Vietnam and Mongolia," they said.

This has resulted in increased trade between countries in the region, and with some outside the block. In 2011 alone, renminbi trade settlements reached 2.58tn yuan ($257bn), up 400 percent on settlements in 2010, which was up to 10 percent of China's total trade.

Slowly and steadily, it has started spreading across other regions. The rise of renminbi is no longer limited to the southeast Asia region, said Subramanian and Kessler. Nine currencies out of 42 outside east Asian nations use renminbi as their reference unit. They include Chile, India, South Africa, Israel and Turkey.

In the first half of 2012, RMB accounted for 10.8 percent of China's trade with the world, a Thai central bank report revealed.

This increase in trade and trading in Chinese currency have happened because of China's rise as a global trading leader. Its manufacturing contribution in east Asia has gone up from just 2 percent in 1991 to 22 percent today.

"The renminbi bloc has now displaced the dollar bloc in Asia. The symbolism and its historic significance cannot be understated because east Asia, despite physical distance, has always been part of the dollar backyard," said the PIIE experts.

Signs of recovery

While RMB has gained ground as a regional alternative to the US dollar, the country has been moving through internal political turmoil and an economic downturn. China's exporters have also began to suffer from the global slowdown, resulting in a lower trade balance.

The quarter ending September, however, showed signs of recovery with industrial production, fixed-asset investment and retail sales recording forward momentum. Factory output is expected to pick up in the final quarter of 2012, putting the country back on track to meet its target of 7.5 percent, Zhu Hongren, chief engineer at China's Industry and Information Technology Ministry, told Bloomberg.

Reduced political uncertainty ahead of the country's once-in-a-decade leadership change and progress in the economic situation has resulted in the rise of the yuan recently. The currency has strengthened over two percent against the dollar in the past two months.

"Earlier this year, people's worries about China's economy increased, which caused a decline in yuan demand," Steven Bell, a fund manager at London-based hedge fund GLC, told Bloomberg. "The trend of outflows has now reversed and China will probably attract more inflows."

Another reason for the upswing is attributed to US politicians hammering China. Both Democrats and the Republicans repeatedly say the Chinese currency is kept at artificially low level value and that hurts American exporters.

During the televised presidential debates, Republican presidential candidate Mitt Romney said he would declare China a "currency manipulator" from day one if he became president.

Economists feel that the strengthening of the yuan to a two-decade high against the dollar may be the Chinese administration's way of conveying to the Americans they are not ignoring those concerns.

The yuan's rise "helps China head off criticism ahead of November's US presidential election," Barclays analysts Nick Verdi, Olivier Desbarres and Hamish Pepper wrote in a report dated 19 October.

If Romney wins

Eswar Prasad, a Cornell professor and former head of IMF China, argued that the Chinese government had not been lowering the value of the yuan. "It's hard to make the case that China is manipulating its currency," Prasad told Bloomberg TV. "The RMB has appreciated and they have allowed for more flexibility".

If Romney wins, Prasad expected him not to follow through his threat to go after China's yuan policy. "The currency manipulation charge is something Romney is going to have to walk back from if he is elected," said Prasad.

RMB as the regional benchmarking currency in Asean and the potential of it replacing the US dollar in future is a major worry for the White House and Wall Street. Just as the US economy overtaking the UK economy during the 1920s propelled the dollar to replace the pound sterling as a benchmarking currency, if China outstrips the US then its currency too could become pre-eminent on the global stage.

The potential of renminbi to rise to the level of an international currency depends on the economic reforms the new leadership brings in after the power-transfer.

With an eye on trade and the other on currency, China announced in September that it would trade oil in its own currency, not the dollar. The decision sent shivers through Western money markets as it undermined a decades-old agreement with the House of Saud.

With the continuing storm in the eurozone and slow pace of a US economic recovery there is a conducive environment for the rise of renminbi in international trade.

Wide-ranging reforms in financial markets, including the liberalisation of the capital zone to allow greater access for foreigners to RMB, could give a real push to the yuan to rise to the level of an international reference currency within a decade.