Yuan move hasn't dented the dollar's dominance in global trade

Meanwhile, if China continues to rely on the dollar as the major currency of trade and investment, it will continue to be exposed to US policy and problems. We have already witnessed the problems caused by acute dollar shortages in the wake of the Lehman Brothers collapse, and also how spillovers from US quantitative easing impact on emerging-market economies.

The use of yuan in international transactions has grown with the growth of China’s trade and investment in the rest of the world, encouraged by Beijing. The yuan’s share as an international payment currency by value has increased from about 1 per cent in 2013 to about 2.5 per cent currently, ranking it about No 4 or 5 among major currencies. 

This share will grow larger in the future as more trade and investment between China and the rest of the world is done in yuan. However, the true test of the yuan’s importance as an international currency is not whether China’s international transactions are made in yuan, but rather whether a substantial percentage of transactions between third parties (other countries) are in yuan. In this regard, the yuan still has a very long way to go.

The dollar remains the currency of choice for third-party transactions. Table 1 reveals the proportions of different currencies Thailand uses to trade with the EU, Japan and other Asean countries. The dollar is the most-used currency, whether for exports or imports and whatever the status of the trade partner’s own currency. This demonstrates the dominance of the dollar and why it remains the pre-eminent reserve currency, as central banks need to ensure there is enough liquidity of the core currency used for trade and investment.

The dollar dominates not because the US forces traders to use it, or central banks to maintain it as the majority of their reserves. These are voluntary choices. The bottom line is that the dollar is the best currency to use for international trade because it minimises transaction costs and has extensive potential investment benefits.

Take the example of exchange rate transaction costs in Thailand. Table 2 shows bank transfer sell-and-buy rates in Bangkok for a number of currencies and also the gaps between the rates. The sell-buy gap for the dollar is much lower than for any other currencies. So for exporters or importers who need to change back and forth between foreign currencies and the local currency, the dollar is by far the cheapest currency to use. The yuan, meanwhile, lags far behind.

The primary reason the sell-buy gap for most currencies is large is that there are no direct exchange markets between that currency and the baht. For example, trading yen for baht and vice versa has to go through the dollar. The result is that the gap between exchange rates for the baht and the yen is about 2.74 times that between the baht and the dollar. For the yuan, the gap is about 4.2 times.

Japanese banks have indicated that the reason they don’t operate a direct yen/baht exchange market is they want to be able to square their exchange risk position daily, but this is not possible because there are no forward markets between the yen and the baht. Clearly, as there is no spot market, there will not be a forward market. So this is a situation of market failure; government intervention is needed to establish these markets. These forward markets also provide numerous hedging instruments to reduce exchange rate risks for traders and investors.

If the yuan is to eventually rival the dollar as a major international (and reserve) currency, government action to set up direct exchange markets between the yuan and other currencies should be a priority. This will make using the yuan for international transactions more attractive and also pave way for the development of derivative markets featuring hedging instruments that will reduce exchange rate risks when using the yuan. Although some direct exchange markets for the yuan are being established, there is still a long way to go. Also significant is access to deep markets for yuan financial assets. This would increase the potential benefits of holding yuan. Again there is a long way to go here.

Apart from direct exchange markets for yuan and other regional currencies, markets between various major regional currencies also need to be developed. This will facilitate the development of the region’s capital markets. Since the East Asian financial crisis, there has been much discussion about the need to develop East Asian capital markets in order to keep our saving surplus within the region, rather than recycle it to finance the US deficit and then have “hot money” flowing back to East Asia with all the problems that it can cause. The development of deep and well-functioning currency markets in the region will reduce the transaction costs of investing and earning in our regional currencies and help to promote the region’s local currency capital markets.

 

Chalongphob Sussangkarn is a distinguished fellow of the Thailand Development Research Institute.