Investing in the Chinese Yuan: Appreciation Imminent?

With the impressive economic growth in China, many investors are getting interested in owning Chinese currency, aka the Yuan (which translates as round coin) or Renminbi. The distinction between the two is that the Yuan is the actual unit of currency while the Renminbi is name of the Chinese currency. A good comparison would be the difference between the British Sterling and Pound. In this article we will touch upon the history of the Yuan, its future as a globally currency and how investors can invest in the Chinese currency.

Before the introduction of the Yuan as the official currency of China, copper and silver coins were the currency of choice. In 1889, the Chinese government introduced the Yuan. Interestingly, the Yuan was originally pegged to par with the Mexican peso because the peso was widely circulated in Southeast Asia due to the large Spanish presence in the region. In the 1890s, the Imperial Bank of China issued notes to many local and private banks. Silver and copper coins were the original issues of the Yuan and were minted at various locations. In 1903, the central government began issuing its own coins. Copper coins were the cheaper version with the silver coins being larger denominations. In the mid 1910s, the Fengtien Yuan was introduced because of the warlord Zhang Zuolin in Manchuria. Zuolin’s Fengtien Yuan appreciated and was at times more valuable than the original Yuan, until 1925. In 1925, Zuoilin had amassed so much territory that the Fengtien had to be mass produced, which lowered its value. Zuolin was assassinated in 1928, virtually ended the reign of the Fengtien. After Zuolin’s death, many local, national and foreign banks issued currencies in China. The Japanese invasions in the 1930s led to many new regulations on Chinese currencies. Circulation of silver Yuan coins was prohibited and private ownership of silver was banned. Banknotes were issued in their place and were known as Legal Tender. Japanese occupation lasted between 1932 and 1945. After the Second World War and the ensuing civil war, China suffered from hyperinflation. To combat the rising prices and the virtual worthlessness of their currency, the Chinese introduced the gold Yuan, which was worth 3 million old Yuan. The gold Yuan suffered from hyperinflation during the civil war years and was finally changed to the silver Yuan. In 1955, the communist government introduced the Renminbi Yuan which is used today. The Yuan has mostly been pegged to the value of the dollar until recently. The explosive growth of China recently (the Chinese GDP has increased fourfold since 1978) has increased pressure globally to let the Yuan float freely, which it started to do in 2005, kind of.

The recent financial turmoil across the globe has weakened the role of the US dollar as the currency of choice for business around the world. The dollar has depreciated roughly 40% in the past ten years. In a recent International Monetary Fund meeting, the IMF spoke about expanding the Special Drawing Rights. The SDR currently is made up of the dollar, euro, yen and pound and is getting closer to becoming a global reserve currency. To be included in the SDR, the country must be a major exporter and the currency widely circulated. Inclusion of the Yuan would signal the recognition of China’s growth as well as encourage Beijing to speed up reform.

Earlier this year, China and Russia reached an agreement to allow their currencies to trade on spot inter-bank markets. Although this move will allow the two currencies to freely trade and therefore promote growth between Russia and China, it reduces their reliance on the US dollar. Annually, trade between the two countries is approximately $40 billion which was exclusively done in dollars, until earlier this year. The dollar is still the primary currency of global trade, but this agreement marks the end of the era for the dollar. Last December, India paved the way for alternative methods of payment for crude oil from Iran. Unless we see some sort of catastrophic event, the dollar will be able to hold on as the global currency, but it will be in a smaller and smaller role each year.

The Chinese Yuan is still not yet completely convertible on global capital markets because its capital markets are not fully developed and foreigners have no access to Chinese government securities. China is trying to influence the US financial system since it hold the single largest amount of US debt. The Chinese government began to allow Chinese companies to use the Yuan to settle international debt in 2009. The Chinese government has also promoted state owned companies to use the Yuan in transactions as well as permitting domestic companies to shift their Yuan offshore. It is predicted that by 2020, a significant portion of China’s international trade will be settled in Yuan rather than dollars. Although the Yuan will certainly increase its role in global currency, it is decades away from completely replacing the dollar or euro.

The Yuan has been growing in popularity as the chances for it to appreciate (once it is fully allowed to float) are pretty high. Foreign investors have a couple of ways to buy Yuan: the Hong Kong offshore market or via the Bank of China. The Hong Kong offshore market recently set the Yuan at 6.4753 to the dollar. Activity has started to soar this year, with deposits coming in at about $1 billion a day. The Yuan has been appreciating over the past few years but the Chinese government has set strict limits as to not hurt exports. In New York, the Bank of China recently allowed foreign investors to buy $4000 worth of Yuan. This type of easy access to their currency shows that the Chinese want their Yuan to be a widely used global currency. United States businesses can now covert dollars into Yuan as part of trade.

In conclusion, appreciation of the Yuan seems fairly imminent as China grows both economically and politically on the global stage. After a fairly convoluted and storied history, the Yuan finally looks to have stabilized. As the deal with Russia shows, China expects the Yuan to replace the dollar in some transactions, although complete replacement seems decades away, if even possible. There are various ways to invest in China and the Yuan, from buying bonds, stocks or the outright currency. There are still extremely tight restrictions on foreigners buying Chinese assets. These restrictions should start to lighten up in the coming years as global demand increases, as long as it is in the Chinese best interests.