China Permits Yuan Trading

The China Central Bank has permitted the use of the yuan and its derivatives as a means to trade outside of China as reported in China Daily. Specifically it says:

"China's central bank yesterday released a rule permitting companies in select cities to settle cross-border trades using the yuan, as part of efforts to reduce reliance on the US dollar for international trade.

Banks will be able to offer yuan settlement services from now on, PBOC said in a statement on its website. It said tax authorities were working on the specific regulations for rebates.

The move, it claimed in the statement, would likely reduce companies' exposure to foreign exchange risks, increase liquidity in foreign trade and cut transaction costs.

"Companies in China and neighboring countries are facing relatively huge risks of exchange-rate fluctuations because of big swings in the US dollar, the euro and other major settlement currencies in the wake of the global financial crisis," the central bank said."

The article continues:

"The government in April said it would allow Shanghai and four cities in the southern Guangdong province - Shenzhen, Guangzhou, Zhuhai and Dongguan - to settle international trade in the yuan on a pilot basis. Companies in these cities, and elsewhere, currently have to convert yuan into dollars or other currencies to settle their export-import bills.

The central government approved the use of the yuan to settle cross-border trade with Hong Kong on June 29. The first transactions will start this month, according to Hong Kong Monetary Authority Chief Executive Joseph Yam, who signed a supplementary agreement with central bank Governor Zhou Xiaochuan the same day. '

This is a dramatic move which seems to have been unrecognized in thee western press. Currently the renminbi is the PRC currency with the yuan being a principle unit. Also before this release all trades were dollar denominated yet the renminbi was used in China, Hong Kong, Taiwan, Russia, North Korea, Burma and Vietnam. Now it will be the basis for a great deal more trade. We see this a a strong step by China to establish the yuan as a bases currency and is a direct challenge to the dollar. One would suspect that the China's banks are concerned about the soon to materialize inflationary pressure on the US dollar.

We would suggest watching this development as it matures.