by the Editors
December 28, 2011
The agreement announced between China and Japan
to strengthen financial ties and promote yuan-yen trade is a small, but
notable, step toward a new global economy.
Its immediate practical
significance is limited, yet the deal signals that a deeper transformation
is under way - and one that the world should welcome.
The plan was a surprise:
It marks a warming of relations that had been
chilly of late.
The accord still lacks a timetable for implementation, but
once in force it will let Chinese and Japanese trading companies switch
between yuan and yen without converting to dollars first.
encourage commerce by reducing currency risk and trading costs.
The agreement will let a Japanese-backed institution sell yuan bonds in
China, helping to open China’s capital market. In return, Japan will convert
some of its foreign-exchange reserves into Chinese bonds. China has signed
financial pacts with other nations, mainly in Asia, but the size of
China-Japan trade - $340 billion last year, and growing fast - makes this
deal the most important by far.
Warmer relations and short-term benefits for regional trade, though, are not
the main reasons the agreement matters. China seeks a bigger role for its
currency in global markets, and wants power in international forums that is
commensurate with its economic might.
The sooner its currency is fully
convertible and its economy is open to global investment, the sooner this
Nudging the Yuan
The deal points the way, nudging the yuan toward its inevitable status as a
global reserve currency alongside the dollar, yen and euro. For all parties,
this process has both benefits and costs, but in the end all stand to gain.
A fully internationalized yuan would be free to appreciate. China’s trade
surplus, a destabilizing force in the world economy, would then be
self-correcting, and the friction in U.S.-China economic diplomacy would
The U.S. had a $273 billion deficit in the trading of goods with China last
year, a figure that U.S. politicians of all stripes find intolerable. On
Dec. 27, the U.S. decided not to designate China a “currency manipulator,”
and instead pointedly criticized China’s resistance to greater exchange-rate
Republican presidential candidate Mitt Romney isn’t so
As one of his first actions in office, he says, he would bring a
currency-manipulation case against China at the World Trade Organization.
The risk for the U.S., if the yuan strengthened abruptly, would be higher
interest rates and inflation, reflecting the shift by investors away from
the dollar to the yuan, and the steeper cost of Chinese goods.
The risk for China would be a too-sudden squeeze on its exporters.
longer term, though, avoiding the huge imbalances caused by China’s
undervalued currency would be good for everybody, and not least China, where
the cheap-yuan policy misallocates investment and suppresses living
When the dollar loses its pre-eminence as a global currency, the U.S. will
need to adjust. Dollar bills in circulation are, in effect, a gift to the
U.S. - they cost cents to print yet they buy a dollar’s worth of goods and
services, a hidden form of payment that economists call
stronger yuan will transfer some of this seigniorage to China.
More important, creditors may look more cautiously at U.S. bonds if the
dollar becomes just another currency.
If by then America hasn’t beaten its
addiction to public borrowing, this change would force the U.S. to do so,
and the experience could be unpleasant.
Badge of Leadership
Not to be discounted are the symbolic, as well as material, benefits
associated with printing the world’s leading currency. It is a mark of
prestige and a badge of global leadership, which is precisely why China
longs to share it.
America might be tempted to resist or resent this
development, but that would be a mistake.
A grown-up yuan means a more stable world economy, which would hugely
benefit the U.S.
In any case, China’s size and vitality assure both its
geopolitical strength and the yuan’s eventual standing as a global currency.
Resistance is pointless....