The Chinese Yuan vs. the Dollar
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The only other currency that could conceivably be considered an alternative to the dollar is the Japanese yen. However, more than a quarter of Japan's $8+ trillion government debt is short-term, and Japan has the highest ratio of debt to GDP of any wealthy country. This limits the long-term desirability of the yen as a trading currency.
The Chinese yuan is not yet convertible on the capital account, its capital markets are not yet well developed, and foreigners have no access to Chinese government securities. However, if as anticipated the Chinese government does eventually make the yuan fully convertible and is successful in developing its capital markets to become competitive internationally, the yuan is perhaps best suited to become an alternative to the dollar over the next two decades.
China could in theory seek to influence the US financial system in the interim in a variety of ways, but given its own vast holdings of dollars, any significant decline in the value of the dollar would not be in its own interest. There is no "cost free" way for China to disengage itself from its own reliance on dollars.
In an effort to reduce its reliance on the dollar, the Chinese government began to allow Chinese companies to use the yuan to settle international trade transactions in 2009. The government has also promoted the practice of state-owned companies using the yuan to make acquisitions, and has just taken an important step in further internationalizing the role of the yuan by permitting domestic companies to shift yuan offshore for investment purposes. This attempt to internationalize the yuan is being done while the government is maintaining extensive capital controls – in essence, having its cake and eating it too – an unsustainable approach over the long-term.
In the absence of any realistic alternative to replace the supremacy of the dollar, it is likely to remain the dominant global currency for many years to come. No other currency is more widely accepted or used. Unless some coordinated action is taken by the world's leading governments to supplant the dollar, China's savvy push to enhance the perceived future value of the yuan is likely to result in stronger bilateral trading relationships and greater flexibility for Chinese companies, but little else for the foreseeable future.
Daniel Wagner is Managing Director of Country Risk Solutions, a political and economic risk consulting firm based in Connecticut, USA. Joseph Tam is a graduate of the London School of Economics in Comparative Chinese Politics, and is based in London.
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