Bank of China Will Allow U.S. Yuan Trading in Game-Changing Step Toward Creating Global Currency

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State-owned Bank of China Ltd. has announced that it will allow U.S. customers to open yuan accounts to buy and sell China's currency.

According Money Morning Chief Investment Strategist Keith Fitz-Gerald this is yet another deliberate move by China, which is attempting to promote the role of its currency in global trade.

"Prior to July 2010 such trading had been confined within China," says Fitz-Gerald. "Then, the government allowed limited yuan trading in Hong Kong, which has surpassed all expectations by blossoming literally from zero to more than $400 million a day. Against that baseline, here they come and here the Yuan comes."

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While U.S. customers can already trade yuan through some Western banks, this move signifies the progression of China's goal to internationalize yuan trading.

BOC will limit individuals to $4,000 in trades per day and $20,000 per year, to prevent speculation in the currency. But there is currently no limit on firms and businesses, as long as they are involved in international trading.

"We're preparing for the day when renminbi becomes fully convertible," Li Xiaojing, general manager of BOC's New York branch, told The Wall Street Journal. The bank wants to be "the renminbi clearing center in America."

The move is also geared to reduce reliance on the U.S. dollar and push the yuan into a greater role as a global currency. Many are concerned that the U.S. dollar's value will decline as the U.S. Federal Reserve maintains its loose monetary policy. China, which holds nearly $3 trillion in foreign exchange reserves largely in dollar-denominated assets, is particularly concerned.

"China sees the global financial system as too U.S.-centric and dollar dependent," Robert Minikin, senior currency strategist at Standard Chartered Bank in Hong Kong, told The New York Times. "That created issues during the financial crisis."

Zhou Xiaochuan, Governor of the People's Bank of China (PBOC), in 2009 released an essay entitled "Reform of the International Monetary System" on the central bank's Web site calling for the dollar to be dismissed as the world's main currency reserve.
China also has signed billions of dollars in currency swap agreements to promote the yuan's use in international trade. And most recently, Chinese regulators last month increased by 7,000 the number of exporters that are allowed to use the yuan to settle global trade transactions.

Analysts predict that within a few years about 20% to 30% of China's $2.3 trillion of imports could be settled in yuan instead of U.S. dollars, up from the less than 1% today.

Money Morning's Keith Fitz-Gerald says this shift to the yuan is something for which the United States is not prepared.

"Arrogant U.S. officials will be stunned in a few months by the giant sucking sound this is going to create in the dollar," said Fitz-Gerald.

Fitz-Gerald calls China's recent move a "monster game changer," and said the yuan is on its way to meeting its global currency goal.

"Watch the yuan become a store of value on par with the U.S. dollar, the Japanese yen and the euro within five years, and still remain nearly completely outside the traditional western currency trading pairs and the sovereign debt risk that makes them all but worthless - quite literally and figuratively." said Fitz-Gerald.

Fitz-Gerald said China's other three big China state-owned banks - China Construction Bank Corp., Agricultural Bank of China Ltd. and Industrial and Commercial Bank of China - will shortly follow BOC's new policy, further broadening the yuan's liquidity. They will compete with each other for yuan clearing services, shutting out unprepared U.S. financial institutions.

Yuan trading by offshore entities will skyrocket as institutions jump on the trade. While most U.S. corporations settle in U.S. dollars, the yuan's appeal is growing. McDonald's Corp. (NYSE: MCD) and Caterpillar Inc. (NYSE: CAT) recently became the first U.S. non-financial companies to sell yuan-based bonds in Hong Kong.

Fitz-Gerald also said U.S. consumers should brace for higher inflation as the yuan strengthens and raises the price of Chinese goods.

"The loudmouths in Washington who believe that China's yuan is undervalued are now going to get a terribly painful lesson in how the real world works when a country with $2.8 trillion in reserves starts calling its own shots," said Fitz-Gerald.

U.S. Treasury Secretary Timothy F. Geithner has repeatedly asked China to revalue its currency, claiming it is too cheap against the U.S. dollar and gives Chinese exporters an unfair advantage. China's trade surplus with the United States increased by 26% in 2010 to $181 billion.

Geithner said in a speech yesterday that while China's tight exchange rate control has kept the currency "substantially undervalued," both countries were starting to see benefits of the yuan's recent appreciation.

"We're probably….at the end of the second inning…but it is changing and it has to happen," Geithner said.

The dollar has dropped to 6.6 yuan from 6.83 at the start of the year. The yuan currency is strengthening at a 10% rate when accounting for Chinese inflation.

"So if that appreciation was sustained over time, it would make a very substantial difference in correcting what is a major distortion for the Chinese economy and the global economy," Geithner said.

China in June by agreed to increase yuan flexibility by allowing the currency to move up to 0.5% each day.

"Conditions are in place for sustained yuan appreciation against the dollar," said Standard Chartered's Minikin, who predicts the yuan will move 6% this year to 6.20 per dollar.

Fitz-Gerald said this development solidifies for investors why China is such an important part of the New Year.

"If you haven't already bought yuan as part of your Chinese investing program, now's the time to do so," said Fitz-Gerald. "Having the yuan on the world's stage will unleash a wave of purchasing power the likes of which the world has never seen and it is a game changer in the truest sense of the world."

[Editor's Note: China's campaign to transform the yuan into the world's new reserve currency is so crucial a development for investors that Money Morning will be following the story with a four-part series beginning next Tuesday. Be sure to check in for more insight from Money Morning Chief Investment Strategist Keith Fitz-Gerald.]

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