Rise of the feedback: how the renminbi is replacing the greenback as the dominant trade settlement currency in Asia.

• Author: Lo, Chi

The renminbi, or yuan, is not going to replace the U.S. dollar as a global reserve currency anytime soon. But it may displace the U.S. dollar as the dominate trade settlement currency in Asia. What's more, a renminbi currency bloc is emerging in Asia, quietly countering the U.S. dollar bloc. The rise of the yuan to challenge the U.S. dollar in Asia is a natural result of changing economic gravity pulling the regional economies towards China. These creeping trends will stealthily erode the U.S. dollar's dominance and reflect the shift of economic clout from the United States to China.

In pushing for renminbi internationalization, Beijing has been introducing new initiatives to broaden the offshore demand base for the renminbi. They include allowing all Chinese firms to settle foreign trade in renminbi with any country in the world, approving the usage of renminbi for foreign direct investment in China, allowing more Chinese entities to issue renminbi bonds in the offshore market (mainly in Hong Kong at this stage), directly trading Australian and Canadian dollars (in addition to U.S. dollars) against the renminbi onshore, and approving the so-called RQFII (Renminbi Qualified Foreign Institutional Investor) scheme, which allows offshore renminbi to be invested in China's capital markets through a quota system. The list will grow over time.

All these measures are meant to create a two-way trading mechanism for the renminbi between onshore and offshore markets, encourage offshore renminbi asset creation, and create an incentive for China's trading partners and foreigners to hold and use the renminbi as an investment and reserve currency, although they are not necessarily and directly helpful for increasing the renminbi's circulation overseas. The point is that successful measures to enlarge the offshore renminbi market will greatly increase the ability of the yuan to erode the U.S. dollar's global dominance.

SINO-JAPANESE TIE-UP

Of particular importance is the Sino-Japanese collaboration, announced on Christmas Day in 2011, for using renminbi for trade and non-trade transactions. In this move, China will allow Japan to make foreign direct investment in China using the renminbi as the investment currency, develop a renminbi/yen foreign exchange market to promote trade settlement in renminbi in Japan, and encourage Japanese entities to issue renminbi bonds in Tokyo and other offshore markets. Japan has also pledged to buy up to $10 billion in...