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February 20, 2011

the Case for China moving the yuan over 10-15 years to reserve currency and how to invest for yuan appreciation

Der Spiegel discusses how China would like to make the yuan one of the world's anchor currencies, forcing other countries to maintain reserves of Chinese money and providing significant advantages for Beijing. Yet the country cannot continue to keep the value of its currency artificially low if it hopes to become the world's dominant economic power.

Forbes - If the yuan is appreciating at 10% a year, as Treasury Secretary Geithner suggests, then the yuan will double in value to the dollar in 7 years

The most direct way to play the yuan is to buy CYB, the ETF that will rise with the yuan, as it is solely invested in yuan forward contracts. It is sponsored by Wisdom Tree Investments, and has assets of $640 million, taking Treasury bills and using them to purchase forward contracts in the Chinese currency.

Or you could buy shares of Chinese natural resource companies like CNOOC, the oil giant, or a Chinese coal or copper producer.



The United States superseded the British Empire after World War II, when the dollar replaced the British pound as the dominant currency in the global financial system. This explains why Beijing has pursued the internationalization of the yuan since the outbreak of the global financial crisis, which the Chinese believe has irrevocably harmed their American rival.

China has a lot on its plate. Today the renminbi -- the official name in China for the "people's money," which is adorned with a portrait of Mao -- cannot even be freely exchanged into another currency. To keep the prices of its exports artificially low, the country also essentially links the exchange rate of its currency to the dollar. Until now, Beijing has used a complicated system of foreign currency controls to effectively shield the renminbi from global capital flows.

In order to have a reserve currency, China would have to give up all of this. It would have to gradually appreciate its currency, perhaps even allowing it to float freely, so that the exchange rate could be based on the real value of the currency and the strength of China's economy. This would make the country's exports substantially more expensive and would drastically curb growth.

Last year alone, the state-owned banks issued loans worth about 8 trillion yuan (about €900 billion), and in doing so fueled the massive real estate bubble. If the yuan were freely convertible, China could become a target for speculators, like the Asian Tiger countries were during the 1997 Asian financial crisis, warns Xiang Songzuo of Renmin University in Beijing.

Xiang believes that China needs about another 15 years to turn the yuan into a freely convertible currency. Then he lists all the reforms China still has on its agenda: the transformation of its low-wage industries; stimulation of domestic consumption; and the creation of a transparent and fair financial system. In short, China will have to transform itself from a system of state capitalism, in which the party pulls the strings, into a market economy.

Only then, says Xiang, will the rest of the world accept the yuan as the reserve currency. But is the party ultimately willing to limit its omnipotent control over China's economy? Or, to do so, would it have to become a "product of the past" itself?

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