Wednesday, December 15, 2010

Chinese Yuan Supplanting U.S. Dollar is Good for America

China’s yuan (its dollar), also known as renminbi (people’s currency), is increasingly becoming a means of savings, payments, and financial instruments outside China.  Yuan deposits in Hong Kong banks have doubled in the second half of 2010.  China and Russia have agreed to conduct trade in yuan and rubles.  China has negotiated yuan payments in trade with countries in Southeast Asia and elsewhere.

The yuan is not yet fully convertible.  China controls the amount of yuan that is allowed to circulate outside its borders.  It is, nonetheless, steadily removing barriers to the use of the yuan outside China.  This trend is likely to accelerate, but it is hard to say how fast.

At some point in the future, the yuan will become convertible and acquire the status of reserve currency for countries that want to diversify away from the dollar, euro, and yen.  Reserve status for the yuan is good for the United States.

As the dollar loses its status as the world’s chief reserve currency, the global demand for U.S. treasuries will decline.  China and other Asian countries will no longer fund U.S. deficits.  To offset reduced demand for American paper, the U.S. government will have to pay higher interest, making it more costly to issue debt.  Higher interest means higher taxes to service and repay debt, or higher inflation if the fed prints money to buy bonds.  Losing reserve status for the dollar will pressure the U.S. government to live increasingly within its means.

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