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For a country with strict capital controls and which does not have a market economy, China’s overseas initiatives continue to dominate.
China’s national currency, the yuan, is gaining international prominence, having been used for nearly a quarter of all transactions outside China during 2014.
A marriage of strictly communist business practice in which state ownership features as a major factor within most Chinese corporate entities, very low operating costs and the capitalist ethos of being able to expand commercial enterprises overseas has proven a runaway success for ultra-efficient China, which is now actively promoting the yuan in order to give it a larger role in global trade and investment in the hope that it will become a global reserve currency alongside the dollar, euro and yen.
In 2014, the yuan was used for over $1.6 trillion of international payments, according to information from the Chinese central bank that was published early this week.
This level of rapid growth as an international currency for cross-border payment contrasts with the uncertainty of western reserve currencies, most importantly the euro, which currently faces potential depreciation should Greece exit the European Union leaving the European Central Bank exposed to over 190 billion euros of unserviceable debt, potentially wiping out over a third of its capital.
Indeed, last week’s move by the Swiss National Bank to suddenly remove the 1.20 floor on the EURCHF which created tremendous volatility as the Swiss franc rose dramatically against the euro, sending FX trading accounts into negative balance across the world, and putting an end to some previously long established and well capitalized companies.
These factors serve to create nervousness among traders and investors in Europe which is increasingly indebted, has received bailout after bailout, and is deindustrialized with China having stepped in to produce and export, well, pretty much everything.
China’s rapid industrialization and its place as the world’s number one manufacturer of hardware, electronic equipment and technology is also a clear indicator that, whilst many western economies become increasingly burdened, China is well placed to provide a strong currency for global markets.
If it were not a communist nation, for certain the yuan would already dominate.
Or would it?
A large part of the reason for China’s fiscal strength is purely down to the structure of the country’s political and economic model. Internally, it is run as a strictly communist nation in which the government is vast and employs over 750,000 people, monitors everything with millimetric precision. People do not have mortgages, they do not have personal debt, they do not own their own homes, and are employed by state-owned enterprises which provide minimal salaries, no pensions, no healthcare insurance, no opportunity for progression and no opportunity to set up as a freelance entrepreneur. There is no social mobility, no freedom of movement or choice of profession.
This means that human resources are vast, costs are low and the government is the ultimate winner, giving it enormous global purchasing power.
Added to this, China’s authorities can build and open new factories in a matter of weeks, with minimal bureaucracy and low cost. There is no chance of a new factory being opposed by local residents, or having to be built in an area away from residential neighborhoods. Instead, Chinese government officials decide where to build, clear the area, build the factory and then recruit local employees whilst providing them with the bare minimum apart from food, basic living conditions and an instruction to work efficiently and diligently for very low salaries. China refers to this as ‘social stability’, meaning that the working population will obey as long as they have enough to survive.
This method propels Chinese business into a position in which it is not possible for companies in free market economies to compete, thus creating a very strong economy, and subsequently a yuan which is desirable globally.
Western attraction to doing business with successful Chinese enterprises has spiralled, with quality now high and cost low, and efficiency probably the best in the world, but are subject to strict entry rules which require a western company to have a Chinese partner, with the company owned by the Chinese government, employing a Chinese workforce. With western economies in tatters, many enterprises in Britan and North America and certainly Australia are now doing this. Many large British banks and FX firms have subsidiaries in Hong Kong and Singapore in order to gain from the Chinese market, which is far more important to British firms than any of the European Union nations.
The Wall Street Journal has reported that according to Swift, the international payments provider, 50 countries now use the yuan for at least 10% of their trade with China. It is the seventh most widely used currency in terms of Swift payments, up from 20th place three years ago.
There are now 14 offshore clearing centers for the yuan, the most important being Hong Kong, while 28 central banks have swap agreements with China. Most recently, China agreed to a 7 billion yuan currency swap line with Kazakhstan in December. It already has similar agreements in place with Russia, the U.K. and the European Central Bank, and Sydney, Australia has become home to a yuan clearing facility.
Bearing this in mind, it is possible that Shanghai may take Hong Kong’s place as the hub for conducting business with China.
Although access to the yuan is restricted by China’s capital controls, which prevent the free flow of money in and out of the country, yuan accounts have been available in Hong Kong since 2004, and more recently cities like London and Singapore have begun competing for offshore yuan business.
Alluding to Beijing’s wider ambitions for the yuan, China’s Ministry of Commerce stated today that from next month the ministry’s press statements would no longer include foreign investment data in dollars, only in yuan, although most foreign investment is actually denominated in the U.S. currency.
Over the last few years, FX firms have concentrated tremendous effort on doing business with China, often via representatives in the mainland, with some companies attributing between 50% and 80% of order flow to Chinese traders. Indeed, this is a dynamic which looks set to continue and advance as China’s well-oiled machine continues to advance, and Europe’s juggernaut flounders.