China and Japan have signed an agreement to support the use of their currencies in trade and investment between the two countries, which will give the Chinese yuan a stronger role in the world. Authorities in Beijing has yet to make substantial changes in management of the economy before the yuan become a strong currency as the dollar or euro, reports Wall Street Journal. Economic problems in Europe and the United States undermined confidence in the dollar and euro markets, but investors seeking a safe investment choice have little alternative. China and other countries have challenged the supremacy of the dollar in international transactions and suggested other solutions to the global monetary system, including a greater role for the IMF and the yuan.
These discussions have so far been largely theoretical, but during a visit to China of Japanese Prime Minister Yoshihiko Noda, China and Japan have announced a series of agreements on the use of yuan in trade and investment between the second and third largest world economies, which would somewhat limit the use of dollar in Asia. Specifically, the two countries will promote trade in yuan and yen directly, rather their currencies dollars. In addition, Japan will hold the yuan in its foreign reserves, currently dominated by US dollars.
“Japan seems to implicitly recognize that there will be one dominant Asian currency which will not be the Japanese yen”, said Barry Eichengreen, professor of economic history at the University of California. A Japanese government official said that, in the future, Asian currencies will have greater importance than at present. The agreement is likely to be welcomed by American government, which has encouraged China to support a greater role of yuan. This requires changing the Chinese financial policy, namely reducing foreign exchange intervention of the government, interest rate liberalization, lowering capital flow restrictions and a banking system controlled by market principles, so that the yuan be traded freely.
These measures should lead to appreciation of the yuan, much awaited by the United States because it would allow mitigation of global trade imbalances. According to Chinese state television, the Japanese authorities have informed Washington about the agreement with China before it was made public.
