More Yuan Flexibility in the Works?

With China being one of the world’s top economies, second only to the U.S., you’d expect the Chinese yuan to be one of the most actively-traded currencies. But no, it’s not. One simply cannot trade the yuan in the forex market because it has been pegged to the U.S. dollar.

The Chinese government has had a fair share of criticisms for keeping its exchange rate artificially low. A couple of years ago, I wrote about how the U.S. pointed out that the Chinese had been enjoying an unfair trade advantage for keeping the yuan undervalued.

Since then, China has taken steps to make the yuan more flexible. The developments have been widely deemed to come along pretty slow though.

However, many regard the recent approval of three Chinese government-controlled banks to operate in the U.S. as a significant step in improving the relationship of the two economic superpowers. Yesterday, the Fed approved the U.S. expansion of the Industrial and Commercial Bank of China Ltd (ICBC), China Investment Corporation (CIC), and Huijin Investment Ltd.

They will become holding companies by owning enough voting stock in The Bank of East Asia (U.S.A.) in New York. This is the first time that any Chinese bank has been given a go signal to acquire a U.S. bank.

On top of that, the Bank of China also got approved by the Fed to open another branch in Chicago. Meanwhile, U.S. customers will soon be able to buy Chinese yuans with the Agricultural Bank of China. It has just been recently approved to open a branch in New York and traders will be allowed to borrow up to $4,000 worth of yuan per day.

By letting U.S. banks have Chinese securities holdings, yuan-denominated assets and the Chinese yuan itself will be more openly circulated in the U.S. market, confirming that China is gradually opening its doors to the international community. Looking ahead, this could pave the way for Chinese banks and businesses to expand their reach to the West, not just in the U.S., but in Europe as well.

Some analysts are even claiming that this could be the first step in making the yuan part of the commonly-traded currencies, but let’s not get ahead of ourselves. These recent moves by China and the U.S. certainly seem to be headed in that direction, but there are still plenty of murmurs that this may just be a political decision more than an economic one. For one thing, China and the U.S. are in the midst of improving their relations in their attempt to ease tensions over the global trade imbalance issue.

For now though, the expansion of Chinese banks into the U.S. is a significant milestone when it comes to increasing the yuan’s flexibility. After all, strong demand for yuan-denominated assets in the U.S. could spur yuan appreciation, eventually leveling the playing field in terms of international trade.

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