China's 'little dollar' spreads its wings
By Reginald Smith

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At the beginning of 2010, it is a time to reflect not just on the economic disintegration caused by the still ongoing global financial crisis, but to also see the beginnings of new institutional frameworks rising from the rubble.

The implementation of the China-ASEAN (Association of Southeast Asian Nations) free-trade pact, besides the obvious wins for both sides, will prove to be a vehicle for a large

  

transformation of the currency landscape in East Asia, accelerating the prevalence of the yuan as a regionally accepted currency alongside local currencies and the US dollar.

No, the yuan is not about to be allowed to become freely exchangeable. So its circulation will still have limitations. However, as China becomes the dominant trade partner for the states of Central and Southeast Asia, the yuan will easily become a main currency of commerce, despite a lack of formal international frameworks.

China's trade with its Asian neighbors is growing at a blistering pace. According to ASEAN statistics, total trade with China by ASEAN states in 2008 reached US$192 billion, just shy of overtaking its two largest trading partners, Japan and the European Union. However, the close proximity of China, bordering many of the 10 ASEAN nations, means that cross-border trades, often transacted in cash, have brought large amounts of yuan into these nations where they are even accepted in stores alongside local currencies for domestic purchases.

A similar process is playing out in Mongolia, the Central Asian states, and North Korea. Some countries such as Nepal and Cambodia have freely allowed circulation of the yuan to improve commerce.

Hard statistics on the amount of yuan circulating abroad are difficult to come by. No public statistics are kept by the central government and most numbers are thus published by researchers using data from the border crossings where yuan cash-in-transit has to be reported. In particular, the main routes of yuan to Southeast Asia are through the borders of China's Yunnan and Guangxi provinces; into Central Asia territories such as Kazakhstan and Kyrgyzstan via Xinjiang; into Mongolia and Russia through Inner Mongolia or Heilongjiang; and into North Korea through Jilin province.

The latest firm statistics are reported by Wang Liyuan in 2005 and Tao Shigui of Nanjing Normal University in 2006. Comparing the estimated yuan cash in circulation in neighboring countries from 2001 to 2004 shows some surprising statistics.

In 2004, an estimated 21.6 billion yuan (US$3.2 billion at the present exchange rate) circulated in bordering countries. By 2009, this was estimated to be over 30 billion yuan. Traditionally, the largest repositories for foreign yuan have been the special administrative regions of Hong Kong and Macau. Together, in 2001, they held 45% of foreign circulating yuan. By 2004, this share had dropped to only 23% at 5 billion yuan.

They were exceeded by Vietnam, where an estimated 6.4 billion yuan circulated in 2004, 30% of the total. According to another article by Wang Rong, by 2006, 96% of all cross-border transactions at the Chinese border with Vietnam in Guangxi province were transacted with yuan. The remaining 4% were transacted in US dollars.

Myanmar, China's close ally, tied the total Hong Kong/Macau circulation amount, having 5 billion yuan circulating within its borders. However, due to Myanmar's lower gross domestic product and unstable currency, the yuan has become much more important to daily transactions, especially in the north, and has become known throughout the country as the "little dollar".

An even more striking case is North Korea. North Korea's yuan in circulation in 2004 was an estimated 2.75 billion yuan; it had by then grown over 900% from only 300 million yuan in 2001. This rapid growth is tied to a burgeoning black market in North Korea capitalizing on trade with China whose nexus is at Changbai, a city on the northern shore of the Yalu River in Jilin province. The relative international isolation of Myanmar and North Korea, combined with their dependence on Chinese trade, makes the yuan circulation within these countries much more important despite the lower overall numbers compared with Hong Kong, Macau, or Vietnam.

Of the other countries bordering China, only Mongolia, Laos and Russia seem to have substantial yuan, with 1.25 billion, 650 million and 500 million, respectively. Together, the Central Asian countries could only account for roughly 25 million circulating yuan, according to statistics. For countries not bordering China, the numbers are more uncertain, with Thailand being estimated to have 4.4 billion yuan in circulation, and the rest being uncertain.

The Chinese government is not standing by and taking a hands-off approach to the spread of the yuan. Over the past year, China has completed currency swaps worth 650 billion yuan with several countries and territories, including Hong Kong, South Korea, Indonesia and Malaysia, and even as far off as Argentina and Belarus.

The purpose of a currency swap is to exchange a large amount of the two currencies of each nation at a fixed rate in order to allow trading partners to have yuan on-hand for convertibility or foreign exchange reserves if necessary. Since the yuan is not freely convertible otherwise, it is nearly impossible for governments to aggregate large amounts of yuan at relatively stable market rates.
In addition, the regionalization of the yuan is having some unintended help from several nations that are experiencing severely high inflation, such as Myanmar, or which have recently devalued, such as Vietnam and North Korea. The loss of value of these currencies and the importance of Chinese suppliers to local businesses will likely strengthen the hand of the yuan as a means of regional exchange.

This regionalization is welcomed by China as a first step in making the yuan a global currency. It will one day be followed by a free floating yuan, though this will happen in accordance with a strategy of China's rising economic power and interests rather than due to pressure from Western trading partners. Though the yuan may not be a global currency for years, it is now an essential part of the East Asian financial architecture.

Reginald Smith is at the Bouchet-Franklin Institute in Atlanta, USA.

(Copyright 2010, Reginald Smith)