The Economist magazine forecast in a recent issue that a future multiple reserve currency system could include the Chinese yuan: “The world might drift toward a multiple reserve currency system shared by the dollar, the euro and the yen, or indeed the yuan at some time in the future.”

Meanwhile, the Nihon Keizai Shimbun reported that 37 percent of the Chinese business executives who responded to a survey believed that the yuan would become a “key currency” by 2020. It may not be surprising, therefore, that a paper outlining a strategy to make the yuan an international key currency was presented at a recent conference of the Chinese Society of World Economy.

As for the yen, the paper said it would remain an international currency but would not become a key currency because Japan (1) is unlikely to possess sufficient national power in terms of politics, the scale of its economy and market size in the years to come; (2) has not succeeded in internationalizing the yen due to a lack of currency strategies; and (3) faces lingering animosities dating back to World War II.

On the other hand, China already has a potential national power advantage, and can strengthen it by maintaining high economic growth and active diplomacy.

The yuan is becoming widely used in China’s neighboring countries. As China expands its free trade zone through economic integration with the 10-member Association of Southeast Asian Nations (ASEAN), China should promote wider use of the yuan in the region. At the same time, by cooperating with other Asian countries to set up an Asian currency system, China could create a better environment for making the yuan a key currency.

The yuan, now pegged to the U.S. dollar, should be pegged to a currency basket that includes the dollar and other major currencies; then the weight of the dollar in that basket should be gradually reduced. At the same time, a more market-oriented exchange-rate mechanism for the yuan would have to be introduced. Careful macroeconomic policy should lend more credibility to the yuan. Eventually the yuan will become a key currency along with the dollar and the euro.

Ling Xing-guang, council member of the Chinese Society of World Economy, writes in the International Finance Journal that most Chinese academics do not view the yuan as a key currency. The majority support collaboration among Japan, China, South Korea and the ASEAN countries to create a common currency.

Why then is a proposal made for the yuan as a key currency, which would likely invite objections by Japan and the United States as well as suspicions among the ASEAN countries?

A Chinese friend of mine who studies the Asian currency system says China believes that Japan’s participation in an East Asian Community and an Asian currency system is crucial for Asia’s peace and prosperity, but that Japan might not be very enthusiastic about such participation while giving priority to its military alliance with the U.S. China’s efforts to accelerate economic integration with ASEAN should be viewed as a part of its security strategy.

China is strategically prioritizing political — rather than economic — interests to promote economic integration with ASEAN. For example, China is opening its agriculture market to ASEAN countries even though its farm sector is overpopulated and noncompetitive. China is already allowing mass imports of tropical fruits from Thailand.

At a China-ASEAN summit held in Laos in November, the two sides signed a series of important agreements such as the “Plan of Action to Implement the Joint Declaration on Strategic Partnership for Peace and Prosperity,” the “Agreement on Dispute Settlement” and the “Understanding on Transport Cooperation.”

In coming years, the Pan-Asia Railway and highway links between China and ASEAN nations will be built. Chinese Premier Wen Jiabao has proudly declared that China-ASEAN relations are entering a new stage of all-out, high-speed development.

This year a summit of ASEAN plus China, South Korea and Japan is to be held to discuss an East Asian community. The idea is to institutionalize de facto economic integration and to promote further economic development and security.

Essential to regional economic development is an Asian currency system aimed at controlling exchange-market volatility. A common Asian currency would eliminate exchange-rate fluctuations in the region and facilitate trade and investment.

At present, ASEAN currencies are either pegged to the dollar or to a basket of currencies in which the dollar is dominant. So it wouldn’t be hard for ASEAN and China to shift to a common currency basket in the leadup to a common currency. My Chinese friend says it’s not important what you call it.

Around 1990, few doubted that the yen would become a key currency, but it has not happened because, first of all, Japan has failed to develop effective currency strategies. Reform measures for the Tokyo financial market were too little, too late. Japanese and foreign companies chose to conduct their international transactions abroad rather than at home. And Japan plunged into structural recession while the yen’s internationalization was far from adequate.

Japan has kept its distance from serious talks on an East Asian community and a common currency, probably due to questions about how its alliance with the U.S. would be affected. However, the integration of Asia is the order of the day. If Japan does not join, it will give way to Chinese leadership. It is, therefore, in the interest not only of Japan, but of the U.S., that Japan help guide a new Asia from within. China would also benefit, as a good relationship with the U.S. is indispensable for economic development and security.

Hideo Tamura, a senior writer with the Nihon Keizai Shimbun, compares the yuan to a giant alarm clock without a stop button. The Japanese government, as if awakened from a long slumber, has decided that it should pursue free trade agreements to create a favorable international environment for Japan’s political and diplomatic strategies, including an East Asian Community.

If the government means what it says, one of the first things it must do is improve Sino-Japanese relations. Japanese and Chinese leaders have not reciprocated official visits for three years, and government-commissioned opinion polls show anti-Japanese sentiment in China and anti-Chinese sentiment in Japan rising to unprecedentedly high levels.

Mutual trust between Japan and China is a prerequisite for the creation of an East Asian community and a common currency. Political leaders should be trying harder to establish mutual trust.

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