China's Emergence - by Alan Wheatley

China's Yuan Could Challenge Dollar Role in a Decade
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by Alan Wheatley
Global Economics Correspondent, Reuters
August 30, 2011   Here’s a bold prediction to feed Western worries that power is shifting inexorably to the East: China’s yuan could overtake the U.S. dollar as the world’s principal reserve currency as soon as next decade.

Beijing has been promoting the use of the yuan beyond its borders since 2009 to settle trade transactions. The resulting build-up of deposits in Hong Kong has spawned a thriving yuan bond market.

Internationalising the yuan, also known as the renminbi (RMB), brings with it a host of financial and political benefits. Notably, it allows China to build up claims on the rest of the world in yuan rather than increasing exposure to foreign currencies, especially a dollar that it distrusts.

But the consensus has been that China, as is its wont, would tread gingerly. The ruling, risk-averse Communist Party would keep capital controls in place, thus retaining its grip over the exchange rate and interest rates but preventing the yuan from becoming a truly international currency.

Arvind Subramanian, a senior fellow at the Peterson Institute for International Economics, a Washington think tank, sees things differently.

“Chinese economic dominance is more imminent and more broad-based — encompassing output, trade, and currency — than is currently recognised,” he writes in a new book, ‘Eclipse: Living in the Shadow of China’s Economic Dominance’.

Using an index of country shares in the world’s gross domestic product, trade and net exports of capital stretching back to 1870, Subramanian calculates China is already on the cusp of overtaking the United States as the world’s leading economy. On conservative assumptions, it will soon carve out an unassailable lead.