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Will the Chinese Renminbi Become the New Dollar?

NEW YORK ( TheStreet) -- As topics go it's a pretty hot one and frequently debated in the foreign exchange community: Just when will the Chinese renminbi -- also known as the yuan -- becomes fully convertible and freely tradable?

This has been vexing the minds of academics, politicians and FX market participants alike.

While it took the U.S. dollar around four decades to replace the sterling as a global reserve currency, the pundits are speculating the renminbi could become fully convertible within the next few years and a base currency for commodities. The signs bode well, albeit with caveats.

Global bank HSBC, a heavyweight player in Asia, issued a briefing note in early 2013 saying it expected "the renminbi to become a top three global currency for trade settlement by 2015 and to be fully convertible in five years."

By then it could be one of the world's most traded currencies and on a par with the U.S. dollar and euro. Currently, the renminbi's value is pegged against the U.S. dollar, allowing only modest changes. It is measured against a basket of currencies, mainly the dollar, the euro, Japanese yen and South Korean won. The daily trading price of the renminbi against the dollar is only allowed to float within a narrow band of 0.5%.

Nevertheless, some might have a feeling of deja vu given the Chinese authorities attempted to make the currency fully convertible before in the late 1980s and early 1990s. But with the onset of the Asian financial crisis those plans were seriously postponed in 1996 and made Chinese policy makers extremely cautious.

Chinese policy makers fear that a nationwide liberalization of capital and currency controls would spark a cash exodus. Indeed, according to a recent Hurun report 44% of Chinese individuals holding over RMB10 million (c.U.S.$1.65 million) in their names have plans to emigrate. Hot money flows are also a concern, whereby money is invested to reap short-term profits on interest rate differences between countries.

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