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The dynamic of the yuan

According to Phillippe Waechter, Head of Economic Research of Natixis Asset management, the evolution of China is extremely rapid, and both its accumulation of foreign reserves and its capability to destabilise or stabilise global constructions is frightening...

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China’s economic development since its entry in the World Trade Organisation in December 2001, has grown rapidly. From that step, its engagement in global trade has grown at a spectacular rate. Throughout the years, China has become a key partner for all the countries in the region and a gateway into Europe and the United States. In fact, for a number of Asian countries, trade first passing through China on its way to the USA has been replaced by direct trade with the American economy. Progressively but rapidly, China has become the main trading partner of the Asiatic zone to the detriment of the USA.

A growing force in international trade

China carries considerable weight in international trade. During a rapid developmental phase, China’s raised profile has resulted in a sustainable trade surplus and, in return, a spectacular accumulation of foreign reserves. Because of the extent of its trade and astronomical foreign reserves, China is a major player on the global economy. Very early on, China used its economic and financial weight to make it into such a major player. China is a reflection of how fast times are changing. During the Asiatic crisis of the late 1990s, China did not play a very important role. 13 years later, the global economy could not imagine a world without China. This status gives China considerable intervention leverage as It is forges ties everywhere in the world both in Africa and Latin America, developing and promoting the idea of rapprochement with countries in the south without becoming dependent upon countries in the north. This change is radical in terms of the scale of its economy. In this way, China has rapidly become one of the largest if not the largest trading partners with Brazil. China has also developed a special relationship with the United States. During its developmental phase, the American economy very quickly became a target market for Chinese goods.

By the end of 2010, 18% of US imports came from China. In the same amount of time, Chinese surplus invaded the American debt market, reducing yields. Francis and Veronica Warnock [1] showed, in 2006 that this capital flow lowered the 10 year rates in the US by about 90 points. Capital flows coming from China were, at this point, already significant.

Moving towards a new balance: China versus United States

A new balance between the United States and China is emerging. It operates on two levels, using the considerable US external trade deficit as a reference point which translates into a shortfall in savings in relation to investments. Adjustments to the US economy can be made either by increased savings or reduced investments. Neither option is favorable for the Chinese economy, since increased trade with the US means robust growth for the country’s economy. China, therefore, has a vested interest in helping US savings grow by providing capital flow into the American economy. This way, neither forcing nor accelerating any adjustment to the American economy. If there is a lack of saving, it will not come from the United States, but from China.

The American economy can, therefore continue to grow and consume without any outside imbalances.

This portrayal of the economy has its limits, since it translates into a mutual dependence. This relationship, however, is not symmetrical, as the market is a rapidly developing one in China, attracting investment, but, at the same time, creating strong resentment in the United States. This implicit arrangement between China and the US is workable in the short term, but definitely not in the medium and long term. The accumulation of foreign reserves reflects an imbalance and probably excessive Chinese competitiveness.
In order to have more balanced trade, the price of trade should probably be modified to enable appreciation of the yuan against the dollar. A revaluation of the Chinese currency would be preferable. It is the result of repeated US pressure.

Implementing this change, however, is not a simple matter. If usage of the Chinese yuan is becoming more apparent today, the, currency is still not a convertible one.

The Chinese, it would appear, want to rebalance their model of growth and develop their financial markets before floating the value of their currency. This will inevitable take time. In addition, the Chinese have not forgotten the Japanese experience. They do not want their currency to appreciate too rapidly, as was the case with the Japanese currency. According to the Chinese, since the 70s, Japanese growth has been stifled. They do not want to experience the same misfortune.

China - at the heart of the international monetary system?

If the yuan were to appreciate significantly with all the characteristics of an international currency, then the question arises about what form the international currency could take. Furthermore, there is a sort of historic anomaly here. China’s power is rapidly growing in global GDP and its currency should, as a result, be more utilised. Although this utilisation is growing steadily, the amounts do not come anywhere near to reflecting this growth in China’s influence in global trade.

The point of departure could be when the Chinese GDP exceeded that of the United States. Historically, US power, in relation to that of the United Kingdom, became evident when the American GDP surpassed England’s GDP in 1872. The Chinese GDP could surpass that of the United States in the decade of 2020.

Once this first step is achieved, the currencies could begin to compete. Such a competition between currencies began to occur between the United States and England after the 1st World War with the dollar overtaking the pound sterling after WW11. Currently, the international monetary system is based mainly on the dollar and the euro. One must also be prepared for a time when China could supersede the Eurozone and its currency could compete with the Euro.

A three-way competition between the Euro, Dollar and Yuan is a possibility.


The situation could evolve more rapidly as reference points from the past are not easy to repeat in today’s environment. China’s evolution is extremely rapid, and both its accumulation of foreign reserves and its capability to destabilise or stabilise global structures is frightening. China will have to reassess its power and in particular, its responsibilities in the world trade market. By the same token, the world will have to radically and permanently change. Europeans and Americans must ensure that this situation is not deterministic, and therefore penalise developing nations in the long term.

Philippe Waechter , November 2011

Article also available in : English EN | français FR


[1] Francis et Veronica Warnock : “International Capital Flows and U.S. Interest Rates” - NBER Working Paper No. 12560 October 2006.

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