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The internationalization of Yuan and the role of the Euro

By Nicola Casarini: 0 Comment(s)Print E-mail China.org.cn, January 9, 2014

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With the official launching of the Shanghai free-trade zone (FTZ) at the end of September the Chinese government has set the country off an ambitious plans for economic and financial reforms. If successful after the three-year test period, the FTZ could pave the way - among other things - to the convertibility of the renminbi, creating thus an alternative reserve currency to the dollar.

In an ironic twist of history, the FTZ was launched only a few weeks before the ‘shutdown’ in Washington which basically sent the message that the world’s main reserve currency is not anymore a fully safe haven. An op-ed by Xinhua agency on 22 October 2013 did not hesitate to call for a ‘de-Americanized’ world.

Europe is China’s first trading partner and the euro has now become an alternative for Beijing’s growing currency reserves. [Photo/China Daily]

A few weeks earlier, on 10 October, the People’s Bank of China (PBOC) and the European Central Bank (ECB) had signed a bilateral currency swap agreement for a sum of €45billion (RMB350 billion), the largest ever signed by Beijing. Europe is China’s first trading partner and the euro has now become an alternative for Beijing’s growing currency reserves. In Chinese eyes, the European common currency is instrumental for the internationalization of the renminbi and the creation of a multipolar monetary order.

The China-Eurozone connection

Washington’s ‘shutdown’ in October has increased worries in China that the huge sums invested in dollar-denominated assets - a total of around $2 trillion in US government and quasi-government securities – are at risk of evaporating, after having been debased by the various rounds of quantitative easing. Any investment loss abroad would limit the financial flexibility of China at a time when it is most needed for rebalancing its domestic economy and growth model.

The greenback still accounts for more than 60% of global – and around 55% of Chinese – reserves. Yet, the euro provides China with a formidable alternative. Since the creation of the European common currency in 1999, the Chinese government has started a process of diversification of its reserves that continues today. This process has gone hand-in-hand with calls for the reform of the international monetary system. In March 2009, Zhou Xiaochuan, the PBOC governor, explicitly called for the creation of a new international reserve currency while reiterating China’s support for the euro.

In contrast to widespread scepticism vis-à-vis the euro (mainly stemming from Anglo-American banks and hedge funds), Chinese leaders have consistently been more optimistic, intervening on a number of occasions since the beginning of the euro-crisis to reassure financial markets and European leaders that they would continue to buy Eurozone bonds and bolster the common currency. This was and still is driven by the need to find new but safe investments for China’s growing currency reserves and diversify risk away from the dollar. Political considerations have also played a role: Chinese leaders have traditionally supported a stronger and more united Europe that could work alongside Beijing to counterbalance American primacy.

In the last years, China has accelerated the diversification of its holdings of foreign reserves to such an extent that, today, euro-denominated assets represent around one-third of Beijing’s total foreign currency reserves (which, at US$3.7 trillion, are the world’s largest). This means that Beijing has bought around one trillion euro.

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