Will US debt ceiling deadlock push capital to yuan market?

Illustration: Carlos Latuff

Expert: The role of the U.S. dollar declines

The US Government is BROKE | The 2023 Debt Ceiling

Every few years, there is a bipartisan political farce over the debt ceiling negotiations in the US. It may look like a routine political drama, but quantitative change can lead to a qualitative difference, especially at a time when a global de-dollarization trend is gaining momentum, that is to say, the US trick of raising the debt limit to mitigate its default risk may now be very close to pushing the US treasuries to a dangerous tipping point.

The de-dollarization caused by the US debt crisis and the abuse of the dollar hegemony created unprecedented opportunities for the yuan internationalization, with more and more countries expressing willingness to settle trade in the yuan, but China must proceed with caution.

With the US on track to default without a debt ceiling increase, US President Joe Biden's talks with House of Representatives Speaker Kevin McCarthy on Tuesday failed to make any meaningful progress, with political divides remaining between the two parties, Reuters reported. Biden even told the media that he has been looking at the 14th Amendment as a way to unilaterally work around the debt ceiling, though it will not be a viable short-term solution.

The political stalemate over raising the debt limit has already led to US Treasury Secretary Janet Yellen warning of an "economic catastrophe" if the US fails to meet all government payment obligations, which could happen "potentially as early as June 1."

So far, most people still believe that the two parties will eventually reach a deal to avoid an ugly sovereign default before the deadline, just like what happened every time in the past debt ceiling struggles.

But unlike in the past, a new question has been raised in the market, that is, are the US treasuries still highly liquid? The US dollar's credit is the cornerstone of US treasuries. Because the dollar is an international settlement currency and US treasuries have stable yields and are highly liquid, countries are willing to hold US debt, making the US the world's largest debtor.

Yet, things may be different now with countries accelerating their de-dollarization efforts. The past year saw growing number of countries and regions such as India, Brazil, and the EU trying to establish new settlement systems for their trade.

Under the influence of the de-dollarization wave, some countries have reduced their holdings of US treasuries. Japan, the world's largest holder of US debts, slashed its holdings by $224.5 billion and China by $173.2 billion in 2022.

Moreover, the US' unlimited expansion of the size of its debt has also upset the market with the risks in the US treasuries. According to Yellen's testimony in a congressional hearing in March, gross federal debt would swell to $51 trillion after a decade. The scale and speed of the debt expansion means the US is getting increasingly closer to a real explosion of a debt crisis.

Also, the root cause of the US banking crisis this year is the holding of a large number of US treasuries assets, which shrank significantly in value as interest rates continued to climb. That could be a warning to various governments and precipitated them to speed up the pace of de-dollarization. Since the collapse of the Silicon Valley Bank, international investors stepped up sell-off of treasuries, and prices of all kinds of safe-haven assets like gold have surged.

Of course, de-dollarization is likely to be a long-term process, but once it started, the US treasuries could lose its aura quickly, especially as the US government repeatedly raises debt ceiling or faces risk of default. In other words, as the world realizes that the US cannot and does not have the willingness to control or reduce the size of its debt, the credibility of the US debt as a safe-haven asset is collapsing rapidly.

It should be noted that amid the de-dollarization trend, the yuan internationalization has made a series of positive new developments and breakthroughs. The yuan's international status as a trading currency has been significantly improved recently.

To ensure future development of the yuan internationalization, China needs to ensure liquidity and maintain exchange rate stability. Thus, China's financial markets as well as the yuan's onshore and offshore markets need more preparation to adapt to the new needs. 

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Malaysia taps into the growing importance of the redback:Yuan

The Society for Worldwide Interbank Financial Telecommunication says yuan usage worldwide grew 15.6% between July and August this year.

MALAYSIA’S love affair with the yuan or renminbi is growing, and it is easy to see why.

For one thing, China’s economic clout is rising. It is now the second largest economy in the world, and with ongoing financial reforms by the Chinese government, the yuan is expected to eventually rise to match the country’s economic stature.

For another - and more importantly - China has, in recent years, been growing to be an increasingly significant trading partner to many economies in the world, especially in Asia, including Malaysia.

Bilateral trade between Malaysia and China, for instance, is now seven times higher than it was 20 years ago.
And China has emerged as Malaysia’s largest global trading partner since 2009.

Last year, Malaysia’s total trade with China was valued at RM167bil, up 14% from the preceding year, and accounting for 14% of the country’s total trade.

The Government expects the value of Malaysia’s total trade with China to double in the next five years.

China’s rising prominence, in Bank Negara governor Tan Sri Dr Zeti Akhtar Aziz’s words, presents “a new operating environment” that requires “dynamic response”.

At a recent seminar entitled “Renminbi Trade Settlement and Investment”, Zeti said one of the changes that would shape the international financial system in the years to come was the wider role of the yuan in trade and finance.

As it is, such trend is already taking shape, with yuan usage across the world increasing progressively.

Wider yuan usage 

According to Society for Worldwide Interbank Financial Telecommunication (SWIFT), yuan usage worldwide grew 15.6% between July and August this year, compared with an average decrease of 0.9% across all other currencies. SWIFT further noted the yuan has moved up one position to be the 14th mostly used world currency, with a market share of 0.53%, up from 0.45% in July 2012.

Standard Chartered plc’s report supports claims that the global use of yuan is on the rise, for trade settlement, in particular.

The international bank notes that Asian and European firms, led by those from Singapore and London, are increasingly open to using yuan.

“We see many European and Asian clients shifting away from settlement in US dollars,” Standard Chartered’s Hong Kong-based foreign exchange analyst Eddie Cheung wrote in his report.

Reports by foreign media suggest that yuan trade settlement could run between US$350bil and US$450bil this year, up from US$300bil last year.

It is understood that China is also quietly working on developing new yuan financial centres around the world to expand the international use of the currency.

At present, Singapore and London are the only cities outside Hong Kong that have been allowed to serve as yuan trading centre. China is reportedly planning for the next regional hubs for settling trade deals in yuan to be set up in Latin America and the Middle East.

As part of an initiative to encourage a wider use of its currency and to manage volatility in uncertain economic times, China has been actively seeking to establish ilateral swap agreements with foreign central banks since the onslaught of the global financial crisis in 2008.

To date, China has managed to set up 20 bilateral local currency swap agreements, worth a total of 1.6 trillion yuan (RM780bil), with central banks of countries within and outside of Asia.

This list includes Malaysia, South Korea, Iceland, Argentina, Pakistan, the United Arab Emirates, Turkey and Australia.

China’s bilateral swap agreement with Malaysia is worth 180 billion yuan.

Zeti notes that Malaysia’s trade settlement in yuan is still at a paltry 1% of the country’s bilateral trade with China. “There is, therefore, a significant potential for this to increase,” she says.

Bank Negara is currently on a mission to promote a wider use of yuan for trade settlement and investment among Malaysian corporations as a way to generate cost savings and minimise exchange rate risks.

“A wider use of yuan is only a natural progression, led by China’s rapidly expanding trade volume and its increasing role as the driver of global economic growth,” explains RAM Holdings Bhd group chief economist Dr Yeah Kim Leng.

“For Malaysian businesses with yuan obligations, the shift to the use of yuan will provide a natural hedge and help them reduce risk and lower cost,” he adds.

According to Zeti, Malaysia’s interest in yuan is also notable in the investment option, with yuan deposits in the country’s banking system having tripled within the first seven months of this year.

Focus on Dim Sum bonds

Meanwhile, there is also an ambition to promote Malaysia as the next hub for yuan-denominated debt (or popularly known as “Dim Sum bonds”) in Asean after Singapore. This is led by the growing interest in raising financing in yuan to meet funding requirements.

“Malaysia is well-positioned to realise this growth potential in yuan-denominated bond and sukuk, given our market size and supporting infrastructure,” Zeti argues.

She, however, says the number and timing of yuan-denominated bond and sukuk issuances will depend on the approvals of Bank Negara and the Securities Commission.

To date, there are only two issuances of offshore yuan-denominated sukuk out of Malaysia and a yuan-denominated bond issuance by Malaysian corporations.

“Ultimately, the potential of Malaysia of becoming a regional yuan debt hub will have to be led by natural market forces, that is, supply and demand,” Yeah points out.

At present, Europe, led by Luxembourg, outstrips Asia (excluding Hong Kong) in terms of both the number of issues and the number of issuance locations.

Analysts, however, believe Asia (excluding Hong Kong) will soon catch up.

Anchor currency

According to the Asian Development Bank (ADB), the yuan will eventually become the “anchor currency” for Asia.

This destiny is cemented by the growing use of the currency in the region’s trade and financial markets.

This, however, does not necessarily mean that the yuan will become part of the foreign exchange reserves of Asian countries, most of which still hold US dollar, euro and the Japanese yen, says ADB. Rather, it means that countries that use yuan widely will manage their currencies according to the yuan’s movement.

The consensus view is that there is still some way to go before the yuan can become a reserve currency. That will involve further openness of China’s own financial markets.

At present, the yuan has yet to qualify as a reserve currency due to its lacks of full convertibility as defined by the International Monetary Fund.

Nevertheless, many central banks have already started to diversify their reserves into the yuan. One of these is Bank Negara, which became the first central bank in the world to announce the inclusion of yuan in its foreign reserves in 2010.

It has been five years since China embarked on a plan to internationalise its currency.

Analysts argue that the process of internationalising the yuan is already progressing smoothly, but gradually in a managed way.

In their working paper entitled “Will the renminbi rule?” authors Eswar Prasad and Lei Ye argue that although China still has extensive capital controls in place, they are being “selectively and cautiously dismantled”.

“China’s capital account is becoming increasingly open in actual terms even though by this measure it remains less open than those of the reserve currency economies – the euro area, Japan, Switzerland, the UK and the United States,” they argue.

According to CIMB Research chief economist Lee Heng Guei, China has taken small yet quite successful steps in its quest for internationalisation of the yuan.

However, he says, full-fledged internationsation of the yuan is a still a distant goal.

“China is clearly more influential than in the past and the internationalisation of the yuan has sped up. But it will take many more years, perhaps another five to ten, for the yuan to be fully global and convertible,” Lee argues.

Undervalued or not?

Now, China’s currency policy has for long been a contentious issue with many western developed nations, especially the United States. There has been growing political pressure on China, led mainly by the United States, to increase the value of the yuan.

The United States has been arguing that the yuan is significantly undervalued, hence giving China’s exporters an unfair price advantage over US manufacturers.

The undervaluation of yuan, which, to some, warrants China being tagged a currency manipulator, has even become an important scoring point in the current US presidential campaign between Republican candidate Mitt Romney and incumbent Barack Obama.

A semi-annual report on the yuan by the US Treasury is due to be released on Monday.

It remains to be seen whether the release of the report will be delayed until after the Nov 6 US presidential election, given the political sensitiveness of the issue.

To be fair, since the yuan’s depeg from the US dollar in July 2005, the Chinese currency has appreciated more than 30% against the greenback.

And reaffirming its policy stance of further exchange rate flexibility, the Chinese government in April widened the trading band from +/-0.5% to +/-1% for the yuan against the US dollar.

Peterson Institute for International Economics estimated the yuan four years ago was undervalued by 31.5% against the US dollar. The latest estimate by the Washington think tank in May indicates that the yuan is now undervalued by only 7.7% against the greenback.

CIMB’s Lee contends that the yuan’s appreciation has to be a gradual and longer-term affair to avoid disrupting China’s economic development.

“The gradual and consistent yuan appreciation can be considered a stabilising factor for the (Chinese) economy, especially its export-oriented sector,” he explains.

According to the Royal Bank of Scotland, the yuan’s value is unlikely to change much in the short term, but further medium-term appreciation on account of productivity catch up remains a possibility.

“If the global economic outlook improves in 2013, the yuan is likely to see further medium-term strengthening, with the pace depending on current account developments,” RBS’ Hong Kong-based analyst Louis Kuijs notes.

By CECILIA KOK
cecilia_kok@thestar.com.my


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China, Japan to launch yuan-yen direct trading

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Trade between Asia's two largest economies is about to get a whole lot easier. China's central bank confirmed Tuesday that the country will allow the direct trading of its currency against the Japanese yen starting Friday.



This makes the yen the first major currency besides the US dollar that can be directly traded with the RMB. The move is part of efforts made by China and Japan to strengthen cooperation in trade and financial markets. And it’s a huge step forward for the internationalization of the yuan.

After some excitement in the Asian markets yesterday. The People’s Bank of China confirmed on Tuesday that China and Japan will start to directly trade their currencies in Shanghai and Tokyo from June 1. The move will shore up trade and financial ties between Asia’s two biggest economies, and also marks another step to raise the yuan’s international role.

Japanese Finance Minister Jun Azumi, who announced the decision in Tokyo, stressed the cost benefits behind the move.

Azumi said, "By conducting transactions without using a third country’s currency, it will bring merits of reducing transaction costs and lowering risks involved in settlements at financial institutions. It will also contribute to improving convenience of both countries’ currencies and reinvigorate the Tokyo market."

The step eliminates the US dollar’s monopoly position to set the exchange rate between the two currencies, and follows a deal struck by the leaders of the two countries in December.

Experts say it’s an important move towards the internationalization of China’s yuan currency.

Professor Ding Zhijie, dean of School of Banking & Finance, UIBE, said, "It raises the convertibility of the yuan. And I believe the yuan trading will be accepted by more Asian economies as well as the international markets. It will also push forward the internationalization of the yuan."

Several banks in the two countries, including Bank of Tokyo-Mitsubishi UFJ and Bank of China, will start the direct trading.

Huang Jiaying, trade with Bank of China said, "The move will likely make the yuan accepted by more Japanese investors as well. It will also help boost the possibility of the yuan becoming an internationally-settled currency, which is an important move of propelling the yuan to become an international reserve currency."

And Japan, which in March pledged to buy about 10 billion US dollars of Chinese government debt, is the first economy to connect with China’s yuan. The move is likely to strengthen ties with its biggest
trading partner.

Japan, China to shore up yen/yuan trade

Japan and China will start trading their currencies directly in Tokyo and Shanghai from June 1 in a move that shores up trade and financial ties between Asia's two biggest economies and also marks another baby step to raise the yuan's international role.

The step eliminates the use of the dollar to set the exchange rate and follows an agreement struck by the leaders of the two countries in December, which also involves Japan buying Chinese government debt and efforts to forge a free trade pact between China, Japan and South Korea.

"This is part of China's broader strategy to reduce dependence on the dollar. The yen has been chosen because of large trade flows between the two countries," said Dariusz Kowalczyk, senior economist and strategist at Credit Agricole CIB in Hong Kong.

"Volumes of currency trading on shore are small, but this could lead to an expansion of trading with other currencies. It would be easier for China to expand into other Asian currencies."

Japanese Finance Minister Jun Azumi, who announced the decision in Tokyo, stressed the cost benefits of the move.

"By conducting transactions without using the third country's currency, it will bring merits of reducing transaction costs and lowering risks involved in settlements at financial institutions," Azumi told reporters after a cabinet meeting.

The People's Bank of China noted benefits for mutual trade, but also tied the decision to China's drive to boost the use of the yuan as a settlement currency for trade and financial transactions.

"Developing the direct yuan/yen trading will help form the direct yuan/yen exchange rate and reduce the trading cost for entities and promote the use of the yuan and yen in bilateral trade and investment as well as help strengthen financial cooperation between the two countries," it said in a statement.

A separate statement issued by the China Foreign Exchange Trade System said it will provide a market-making system for direct yuan/yen trading.

Until now yen-yuan rates were calculated on the basis of their respective rates against the dollar, so the move is expected to narrow trading spreads, lower transaction costs and allow more trade deals to be settled directly.

For Japan, which in March pledged to buy about $10 billion of Chinese government debt, becoming the first major economy to do so, the move could strengthen ties with its biggest trading partner.

Despite sometimes rancorous political ties between the two neighbours, Japan's economic fortunes are increasingly tied to China's economic growth and consumer demand.

Dealers in Shanghai said the near-term effect would be probably higher trading volumes and lower costs.

"Direct yuan-yen trading is likely to cut trading costs, boosting yuan-yen trading liquidity," said a dealer at a foreign bank. "Most yuan trading against the yen now goes through the dollar, because traders refer to dollar-yuan value to price yen-yuan."

But some played down the broader impact.

"From what I can see, it doesn't actually include any opening up of the capital account at all. It just allows a direct cross to be traded rather than actually increasing the amount of flow that can happen onshore to offshore," Dominic Bunning, currency strategist at HSCB in Hong Kong, said.

"It seems to be more of a technical issue rather than a major development."

The move to facilitate yen-yuan trading and the debt deal are part of Beijing's long-term efforts to elevate the yuan's status as an international currency, which so far have mainly centred on China's promotion of the yuan to settle trade.

Beijing has struck agreements with several nations from Malaysia to Belarus and Argentina on the use of the yuan in trade and other transactions. It has expanded a pilot programme started in 2009 into a nationwide one allowing firms to settle their trade in yuan.

The result has been a relative surge in the use of the currency. More than 9%of China's total trade was settled in yuan in 2011, up from just 0.7% in 2010.

Few argue against the idea that the yuan will one day become a reserve currency, given World Bank predictions that China will overtake the United States as the world's top economy before 2030. But to achieve that the yuan would need to become fully convertible and Beijing has yet to indicate any timetable for reaching that stage.- Reuters

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• Demise of US dollar as world currency
• Crossover: Investors' reaction to Yuan-Yen direct trading 2012-05-30
• China and Japan to start direct currency trading 2012-05-30
• China-Japan direct currency trading to boost economies, trade 2012-05-29

Demise of US dollar as world currency

Experts see demise of dollar as world currency

 By DORIS C DUMLAO and MICHELLE V. REMO

IT may only be a matter of time before the US dollar gets replaced as the main currency in international trade, according to economists attending the meeting of the board of governors of the Asian Development Bank (ADB) in Manila.

Asian Development Bank, ADB

For many years, the dollar “has been almost the sole ‘reserve’ currency,” banked on by the world economy, American economist Jeffrey Sachs said on Thursday in one of the forums held during the ADB annual event. “Going forward, (the dollar) can’t play that role anymore.”

Sachs added that he could not see how the US dollar could remain as the world’s reserve currency when “the role of the United States in the global economy is diminishing.”

Several finance experts echoed Sachs’ sentiment, explaining that, with the greenback expected to weaken further, the world should turn to another currency to facilitate international trade and other commercial transactions.

“Having another reserve currency other than the US dollar is only a matter of time. We don’t know exactly when it will happen, but it will,” Neeraj Swaroop of Standard Chartered Bank said in an interview at the sidelines of the ADB meeting.

In the area of merchandise trading, Swaroop said, countries have actually started to use currencies other than the US dollar.

Sachs also said that some countries could turn to more than one currency in maintaining their foreign exchange reserves.

One currency being considered is the Chinese renminbi (RMB) which, according to HSBC, will inevitably become an international reserve currency.

The renminbi, or yuan, has the potential to become an international reserve currency because China is continuing to post strong growth, becoming an important player in the global economy, Iwan Azis, ADB head for regional integration, said in the same forum.

Also, China is pushing to make the yuan the world’s reserve currency – a move that is seen to hasten the replacement of the US dollar, Azis added.

Already, British banking giant HSBC has mapped out a strategy to be a leading global player in the “renminbi banking” space.

This global strategy has filtered into the Philippine market with the bank’s introduction of RMB-denominated deposit and trade financing facilities, top HSBC officials said in a press briefing on Thursday.

Spencer Lake of HSBC said the renminbi was increasingly becoming an important currency from a trade perspective.

Lake was in Manila as head of the HSBC delegation to the ADB event.

“If it were freely convertible today, it will be the second-largest currency in the world,” Lake said, noting that China has started to liberalise currency systems.

“It’s part of our core strategy to adopt and put in place all of the infrastructure and products to embrace (the renminbi) as a future reserve currency,” Lake said.

Lake said the bank’s strategy appeared to be gaining ground as indicated by a “significant” buildup of the RMB business in Hong Kong, Singapore and other South-East Asian countries.

“The world is getting ready to adopt it as a world currency,” he said. “You’ll see it as a more common language.”

“Reserve” currency, which is currently used to describe the US dollar, is the denomination that accounts for bulk of the foreign exchange reserves of most countries.

A country taps its foreign exchange reserves whenever it needs to pay off the costs of imported products and debts to foreign creditors.

After the United States fell into a recession in 2009, the US dollar began to weaken against emerging market currencies.

The trouble with hanging on to the dollar as the main reserve currency is that it is prone to depreciation given the prevailing economic troubles of the United States.

Depreciation of the US dollar, in turn, may lead to a reduction in the value of a country’s foreign reserves, experts said.

Apart from the yuan, Sachs said other viable currencies that could replace the US dollar were the euro and the Japanese yen. — Philippine Daily Inquirer / Asia News Network