We have heard a great deal of puffery over the past few months about the prospect of yuan settlement in Hong Kong. According to officials and bankers, benefits will begin to shower around our ears once local companies are able to make or accept payments in yuan for their trade with the mainland instead of pricing transactions in US dollars like the rest of the world. The line from Beijing is that allowing yuan settlement will encourage bilateral trade, helping to overcome the economic slump. To judge by official excitement in Hong Kong, you might think the city had won some rare and special prize that will secure our financial future for decades to come. Last month, Chief Executive Donald Tsang Yam-kuen said yuan settlement would provide 'enormous security' for local companies and 'definitely' create more jobs for the city. Maybe. It's easy enough to see the theoretical big-picture advantages that might accrue from allowing yuan settlement. But if you look on the smaller scale of the individual trading company, the potential benefits are rather less clear. For a mainland-based exporter whose costs are all in local currency, it would make good sense to accept payment in yuan. All foreign-exchange risks would be eliminated and transaction costs significantly reduced. The trouble is that very few exporters boast a cost base entirely in yuan. The local value-added content in mainland exports is generally reckoned to be a shade less than half, and in higher-margin products such as computers, it's considerably less. In other words, although exporters' labour, land, energy and other costs may be denominated in yuan, the bulk of their costs frequently consists of payments for imported raw materials and components that are typically priced in US dollars. Even then, it might make sense to accept payment in yuan in an environment in which the Chinese currency was steadily appreciating. Yet neither steadiness nor appreciation is guaranteed. Although the mainland authorities have kept the currency stable against the dollar over the past six months, as the first chart below shows, if measured against a trade-weighted basket of currencies, the yuan has been uncomfortably volatile and has actually depreciated a touch. The advantages for Hong Kong-based trading companies of settling transactions in yuan are similarly dubious. At the moment, yuan financing is tricky to obtain. Even if it were to be drawn down and the funds made available for trade finance, the 200 billion yuan (HK$227.2 billion) swap facility signed last year between the People's Bank of China and the Hong Kong Monetary Authority would represent only about 16 per cent of Hong Kong's imports from the mainland last year. And companies receiving yuan payments will find themselves severely constrained in what they can do with the money. At the moment, their only option would be to place the funds on deposit at a meagre 0.45 per cent interest rate, even less than they could hope to earn on dollar funds. As a result, with the yuan no longer appreciating against the dollar, it is no surprise the size of yuan deposits in Hong Kong is shrinking (see the second chart). It is likely that these last difficulties will be ironed out in time, once the settlement trial gets under way. Ultimately, however, the reason the vast majority of international trade is denominated in US dollars rather than any other currency stems from what economists call 'network externalities'. This is just a pretentious way of saying it makes good sense to use the dollar for trade, because everyone else uses it, too. That universal acceptance is a huge factor in the dollar's favour and imparts an enormous inertia to the dollar's status as the world's trade currency. So, although there are plenty of theoretical advantages to permitting yuan settlement in Hong Kong, it will be a very long time before we begin to see any real benefits. The reason international trade is denominated in US dollars stems from what economists call 'network externalities'