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What is the Significance of Direct Yen-Renminbi Trading? Impacts on the World Economy

Lim Hua Sing
Professor, Graduate School of Asia-Pacific Studies, Waseda University
Director, Institute of Chinese Economies, Waseda University

Direct currency trading between China, boasting the second largest GDP in the world, and Japan, the third-largest economy, has great importance. From the perspective of China, Japan is its fourth-largest trading partner; for Japan, China is its largest trading partner. Given that the annual amount of Japan-China trade exceeds 27 trillion yen, the ability to directly deal currencies of the two largest economies/traders, bypassing the U.S. dollar will have significant impacts on global finance.

Indeed, China is already trading currencies directly with several Asian and Middle Eastern nations, but it has not had great impacts. The case between Japan and China, however, has provoked active interest among the public.

1. Necessity of directly trading yen and renminbi

Japan has undergone a long-lasting economic slump since 1991, like the lost 21 years after the bursting of the economic bubble. The Japanese yen has remained steady for many years until today. The sluggish economy and the strong yen, or the abnormal yen appreciation, are tormenting industries in Japan. Facing severe population aging and lower birth rates, Japan has a hard time expanding the domestic market and driving domestic consumption. It is crucially important for the Japanese economy to transfer industries overseas and open up international markets. In short, sustainable growth of the Japanese economy inevitably requires larger investment in, and promotion of trade with, China.

China, on the other hand-having enjoyed steady and rapid economic growth in the past 34 years-recently suffers negative impacts from the fiscal crises and economic stagnations in Japan, the United States, and European countries, with an economic downturn becoming more apparent due to a slowdown in international and domestic demand. The double-digit growth for more than 30 years is today a thing of the past, and it will not be easy to maintain even a 7 to 7.5% growth for several years to come. So, China has no choice but to actively drive economic cooperation for trade and investment in Asia, especially with Japan.

Now that it is more important to further strengthen and promote the Japan-China economic relationship, beginning direct yen-renminbi trading would speed up economic exchange and bring the benefit of expenditure reduction.

2. The current situation of direct yen-renminbi trading

Exchange transactions for direct dealing of the yen and renminbi started on June 1 at foreign exchange markets in Tokyo and Shanghai. It is estimated that the two countries will be able to save the brokerage charge amounting to about 3 billion U.S. dollars annually paid to the U.S. Federal Reserve Board (FRB). It would benefit future business development of more than 22,000 Japanese firms operating in China. It is also expected to have positive impacts on Chinese companies, particularly government-owned ones, expanding into the Japanese market. In addition, it may assist the mutual purchase of government bonds between the two countries. Japan and China have long been the two largest holders of U.S. government bonds (1.096 trillion dollars and 1.179 trillion dollars, respectively, as of the end of February 2012), and possess foreign currency reserves of 1.2777 trillion dollars (as of the end of May 2012) and 3.305 trillion dollars (as of the end of March 2012), respectively, of which 60 to 70% are denominated in dollars. Because both Japan and China have continued intervening in exchange markets to maintain the stability of their home currency and prevent its rapid appreciation, the amount of the U.S. dollar reserves is being accumulated more and more. Using this fund, they are purchasing high-yield U.S. government bonds. In order to avoid excessive purchases of U.S. government bonds or an undue emphasis on them, Japan and China agreed on the mutual holding of their government bonds. Strengthened direct trading of Japanese and Chinese currencies would facilitate activities for the mutual purchase of government bonds between those nations, as well as expanding the volume allocated to yen- or renminbi-denominated purchases.

3. The ultimate goal of direct yen-renminbi trading

Direct yen-renminbi trading does not simply bring benefit to both Japan and China. From the mid- and long-term perspectives, the following effects are expected in addition to saving brokerage charges and other costs, avoidance of exchange risks and financial report risks, and promotion of economic exchange between those countries.

(1) China has a policy to gradually break full dependency on U.S. dollars. While U.S. dollars have reigned over the world as a key currency for many years, their large fluctuation has also inflicted significant losses on economies around the world. Recently, BRICs and other emerging economies have achieved rapid growth and more and more international influence. As China and other emerging countries have increased their contributions to international organizations such as the International Monetary Fund and World Bank, they began demanding a voice in proportion to these contributions. At the same time, they hope today that their own currency (e.g., Chinese renminbi) will be used more widely, and proposed gradual application of SDR (special drawing right) instead of U.S. dollars. The purpose of using currencies other than U.S. dollars through direct yen-renminbi trading might be, from an objective point of view, to avoid excessive dependence on the U.S. dollar.

(2) It would contribute to reinforcing Asia-Pacific Economic Cooperation or creating Asian Economic Community. While China has been committed to building ASEAN 10+3, Japan has made efforts toward achieving ASEAN 10+6. Though the realization of TPP remains uncertain in the Asia-Pacific region, it has been a long time since the establishment of a community and the idea of a single currency-for example, ACU and Asian Single Currency-were proposed for the region. Whereas there are movements in Japan for promoting internationalization of the yen, both the public and the private forces in China are hoping and eagerly promoting internationalization of the renminbi backed by the sizable economy. On the assumption that the strengthened direct yen-renminbi trading makes a step toward the internationalization of those currencies, it would also change the tendency of full dependence on U.S. dollars in the Asia-Pacific region. In the future, it might not be a distant dream to build an economic community or create a common/single currency in this region.

In conclusion, the establishment of direct yen-renminbi trading is not a problem for Japan and China alone. It will have deep impacts on the world economy as well as the Asia-Pacific region in the long run.

Lim Hua Sing
Professor, Graduate School of Asia-Pacific Studies, Waseda University
Director, Institute of Chinese Economies, Waseda University

[Brief biography]
Graduated from the Faculty of Economics and Master's Program, Graduate School of Economics, Hitotsubashi University. Ph.D., London University. Has been a Professor, Graduate School of Asia-Pacific Studies, Waseda University since 1998 after serving at the Institute of Southeast Asian Studies, Singapore; National University of Singapore; Chukyo University, and others. Served as an advisor or Visiting Professor at Nankai University, Tongji University, Shanghai Jiao Tong University, Beijing Normal University, Peking University, Sun Yat-sen University, Fudan University, University of Helsinki, Nanyang Technological University, and others. Major publications include The Diastrophism of the ASEAN Economies [ASEAN Keizai no Chikaku Hendo] (Dobunkan, Tokyo); The Four-Polar Economy of Asia [Ajia Yonkyoku Keizai] (Diamond Publisher, Tokyo); Economic Cooperation Among ASEAN, Japan and Chinese Communities (as an editor and author, World Scientific Publishing, Singapore); East Asian Economic Integration (World Affairs Press, Beijing); Analysis of East Asian Economies (as an editor and author, World Scientific Publishing, Singapore); Japan and China in East Asian Integration (Institute of Southeast Asian Studies, Singapore); Achilles' Tendon of Asian Economies [Ajia Keizai no Akiresuken] (an editor and author, Bunshindo, Tokyo); Asia Giants in the Face of the Global Economic Crisis [Nicchuin no Shinka wo Tou: Sekai Keizai Kiki wo megutte] (as an editor and author, Hakuteisha, Tokyo); East Asian Political Economics (World Affairs Press, Beijing); China at the Turning Point [Tenki ni Tatsu Chugoku] (as an editor and author, Sososha, Tokyo); The Road to China's Economic Development (as an editor and author, World Affairs Press, Beijing); and more.