China to speed up Yuan convertibility

The central government wants a piece (or rather, a big chunk) of the reserve currency pie

Over the weekend China’s forex regulator State Administration of Foreign Exchange said in a statement that acceleration of the Renminbi convertibility is one of the major goals for authorities. With the Shanghai Free Trade Zone being the test bed for FX convertibility, 2014 is a crucial year for one of the keys to unlocking the full potential of the Chinese economy.

The Chinese government is up to something – they are continuously voicing their will to increase Yuan convertibility and may that come as no surprise, as they have already seen the benefits that the US economy is claiming from the US Dollar’s status as a reserve currency. There practically is no country in the world that wouldn’t like to have low interest rates and low inflation rates for such a protracted period of time as the US in the past decades.

The United States has enjoyed this benefit since the middle of the 20th century and for now there is no immediate signs of a threat to the US dollar dominated world. While there were some voiceful opinions about the Euro attempting to challenge the status quo, in the end the single European currency turned out to be surrounded by its own issues.

While a US dollar currency crisis may sound pleasant to doomsday prophets, let’s not kid ourselves – China is far from a developed economy and its reliance on exports does put it in a difficult position. It already is struggling with a hot real estate market, declining growth and lately substantial interbank liquidity issues.

More on the last point – soaring RMB money market rates in July and December of 2013 present only one of the big challenges. The PBOC has had to intervene repeatedly to provide additional funds to alleviate an interbank liquidity squeeze. These occurrences have become somewhat of a regular issue last year as the shadow banking system in the country keeps posing serious risks. Arguably liquidity shortages are going to get translated to the public sector and specifically to the local governments.

Over the weekend, the general manager of China Investment Corp. Xie Ping, said that the central government will not allow local governments to default. Since this is the source of the information there is no doubt as to the source of future funding for those. The massive surpluses generated by the exchange rate regime will be used to cover up bad investments on a local government level – talk about redistribution of wealth.

For the foreseeable future there is no threat to the dominant reserve currency status of the US Dollar. However as the Chinese authorities are accelerating structural reforms and their willingness to announce Chinese Yuan convertibility is growing, other currencies used for reserve purposes such as the Euro, Pound, Swiss Franc and Japanese Yen might be the first to experience some pain.

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