NEW YORK (TheStreet) - One of the fundamental characteristics of the global financial architecture is that the world's second largest economy maintains a rigidly controlled currency.The concept of currency wars, as initially articulated last year, seemed to have been a criticism of the easy monetary policy of the Federal Reserve, but is being appropriated and used as a criticism of the lack of flexibility of the Chinese yuan. The reluctance of Chinese officials to allow its currency to be another shock absorber in the circuit of capital means that other liquid flexible or floating currencies have to shoulder a greater burden of the adjustment. Some, like a well respected analyst at a recent industry conference in New York, suggest that as long as Asian currencies remain under-valued that the European currencies will remain over-valued, and by implication other currencies as well. Given the tightly controlled yuan market, the extent of its use offshore is a development that is capturing the imagination of many observers and participants. Entities like the World Bank's International Financial Corp, the Asian Development Bank, McDonalds ( MCD), Caterpillar ( CAT) and some of the largest banks in the world have issued yuan-denominated bonds in recent months. Billions of dollars in trade is being settled in yuan. China has also arranged swap lines with a number of countries, mostly in the region, but as far reaching as Argentina. To date, only Hong Kong appears to have utilized them. As such, the amount of yuan on deposit outside China is growing rapidly. Some observers suggest that this is the beginning of the Chinese yuan becoming a truly global currency and a rival to the privileged place of the U.S. dollar.
China has allowed an interbank market for the yuan to flourish in Hong Kong since last July. If there is a consensus among hedge funds and other speculators, it is that the yuan is going to appreciate in the short and long-term. On the other side are businesses, often Chinese companies owned or backed by the government, which want to borrow yuan to fund onshore operations. Owing to the strong demand for yuan-denominated financial products, the cost of (yuan) capital is less than half of what it is onshore. The yuan raised in Hong Kong is regarded by Chinese officials as a foreign currency (the common pneumonic is CNH to distinguish it from the onshore yuan CNY). The process by which CNH can be brought onshore -- transformed into CNY -- is not yet transparent and has not been standardized as are the procedures for dollars, for which there is a clear channel and necessary steps. The yuan raised in Hong Kong is brought into China on a case-by-case basis. It appears to be guided by Chinese officials to help achieve policy objectives. The location of the borrowing company's mainland operation seems to be important as the provincial governments are ultimately behind the process. In addition, the sector the borrowing company operates is also important. If it is for a sector that officials worry about overheating or excess investment, it is reportedly more difficult to get authority to bring the funds onshore.
Overall, imports plus exports were near $70 billion, but a more appropriate metric may be imports from the mainland. In that respect, more than half of Hong Kong's imports from China were settled in yuan. Note, too, that nearly half of Hong Kong's imports get re-exported. Arbitrate opportunities have made the gap between the CNH and CNY nearly disappear. The mid-October 2010 the CNH was as much as 2.6% richer than CNY. In recent days the gap was 0.07%, while the wide spread drew Chinese companies' interest. Consider a chip maker who was build a new fabrication plant in the province of Fujian. It would need to import capital equipment. The supplier was unwilling to accept yuan as it is not convertible. The company could send yuan to its Hong Kong subsidiary who can swap it for dollars at the better offshore rate.
In late 2010, Chan said that none of the criteria had been met.