What bank research reports don't tell you about the yuan
Yet another research report about how the yuan is set to challenge the US dollar as the world's dominant reserve currency popped into my e-mail inbox yesterday.
I've been sent dozens of these in recent months. The standard of the analysis varies widely, and their length ranges from a few pages to a few hundred. But on the whole they follow the same reasoning.
They note that China is big and growing rapidly, and that it is already the world's largest trading power. They point out that in the past the yuan has been little used outside China. But with faith in the US dollar shaken by the 2008 financial crisis, and with Beijing now actively promoting the yuan for international trade and investment, they argue it is only a matter of time before the currency emerges as a viable rival to the greenback.
To support their argument they invariably show charts like the ones here. The first shows how rapidly the yuan has been adopted as a currency for settling China's foreign trade.
The second chart shows the exponential growth of yuan-denominated bond issues in Hong Kong's offshore market; proof, say the enthusiasts, of the yuan's enormous potential as an international investment and reserve currency.
I don't buy it.
Banks produce these research reports because they want to burnish their credentials as yuan specialists, hoping to capture themselves a slice of one of the few business lines that is actually growing in these tough times.
But that doesn't mean their predictions for the yuan's glowing future will come true.
I've harped on before about some of the practical obstacles, for example, how the yuan's use in trade settlement has been driven overwhelmingly by expectations of the currency's appreciation. As a result, with goods priced in US dollars, Chinese importers have been only too happy to pay in yuan in the belief their bills will fall in local currency terms.
Similarly the growth of the offshore yuan debt market has been propelled by a simple interest rate arbitrage, because borrowing costs are lower in Hong Kong than onshore.
Both reasons for using the yuan are dependent on the whims of the market. The growth of yuan trade settlement has pretty much stalled since it stopped appreciating at the end of last year. And the attractiveness of offshore bond issuance could soon be undermined by onshore interest rate cuts.
But there is another, more fundamental, reason to doubt the inevitability of the yuan's rise to global dominance: despite what Chinese officials say in public, they really don't want to internationalise their currency.
For the yuan to be accepted widely as a trade, investment and reserve currency, offshore players would have to be guaranteed easy access to plentiful yuan liquidity.
There are two ways that could happen. China could run a big trade deficit, which would pump large quantities of yuan into the international markets through China's import payments.
But running a trade deficit would subtract from China's economic growth rate - something Beijing is anxious to avoid.
It might be possible to internationalise the yuan in the absence of a persistent trade deficit. But to do that China would need an extremely sophisticated and fully open financial sector.
In other words, Beijing would have to surrender its control over the country's banking system.
That's not going to happen any time soon. An international currency might help enhance China's prestige and power around the world. But when it comes to vital considerations of domestic power politics, the advantages of maintaining tight state control over the financial system far outweigh any benefits of currency internationalisation.
So it's best to take all those reports about the yuan's golden future with a hefty pinch of salt.