China likes to cover large distances in small steps. In August, it said that a few lucky foreign banks, including central banks, could invest some of the yuan they hold offshore in local Chinese bonds. The first to take up the offer was Malaysia's central bank, the Financial Times reported last week. With that purchase, another stone was removed in the great wall shielding China's currency from the outside world.
Global currencies emerge sporadically -- the dollar in the first half of the 20th century, the euro over the past decade. That China could even have a plausible claim to such a thing is a remarkable turnaround. Its monetary policy and its mints were often in such wretched shape before the 1949 revolution that old Mexican silver dollars still circulated. The very word "yuan" is a contraction of "yang yuan," or "foreign round coin."
After the Communist revolution the currency situation got even worse, with ration coupons playing a role in transactions. International deals went through the creaking hands of the Bank of China or, quietly, through black markets. It was only in 1994 that a unified, official exchange rate was established.
After solidifying the role of its currency in its domestic market, China resisted the next logical step. It kept a tight grip on the flow of capital across its borders. And even as its companies conquered world markets, they priced their goods in other people's money. The limits on conversion allow China's authorities to steer the economy and control business.
But this strategy has exposed China's companies to foreign-exchange risk, one reason why the authorities are reluctant to let the yuan move more freely against the dollar. It also has deprived China of the easy profits that come from buying foreign goods and assets in return for non-interest-bearing pieces of paper adorned with portraits of Chairman Mao.
Cliff of controls
Slowly, however, China seems to be changing its approach. As a result of reforms begun last year, exporters to China can now price their goods in yuan, rather than dollars, and deposit the proceeds in offshore corporate accounts, mostly in Hong Kong. At first the reforms were a flop, says one banker. Few accounts were opened and not much business done.
Offshore accounts offered puny rates of interest because banks could do so little with the money. But as deposits have grown, so has the number of firms seeking to tap them. In the past two months McDonald's has issued a yuan-based bond in Hong Kong, as has Hopewell, a property firm. Both were oversubscribed. Banks and the Chinese government itself also have gone to the well.
The off- and onshore markets are still separated by a cliff of controls. Companies cannot borrow yuan from the mainland; they must earn them through trade. Crudely put, yuan flow out of China only if goods or services flow into China. And offshore yuan do not easily travel back into China either. A currency represents a claim on a country's underlying assets.
"The good news is that those assets in China are ever-growing," said Ronald Schramm, a visiting professor at China Europe International Business School in Shanghai. "The bad news is that with all the restrictions, there are few ways for outsiders actually to cash in on the claim."
Last month's decision to let some banks spend their offshore yuan on local Chinese bonds creates another link between these otherwise parallel universes. It will allow some offshore yuan to climb back onshore in exchange for assets rather than goods. These purchases will be subject to a strict quota, but still broaden the menu considerably. The onshore bond market is after all worth $2.9 trillion, 725 times bigger than its nascent offshore rival.
If global trade in yuan swells, international banks have a good chance of developing other fee-generating, predictable businesses, such as handling letters of credit or payments. And since money on its way from one place to another inevitably pauses, there should be more rises in deposits, which become the stuff of loans.
And yet, for all the financial logic, there is a huge argument going on within the Chinese government about whether to proceed. If foreigners sell their dollars to hold yuan, they will put upward pressure on the currency, making the exchange rate harder to "manage" (to use the word China prefers) or "manipulate" (to use the word preferred by its critics).