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Dollar shortage drives down offshore Yuan

WSJ reports:

Until this week, the Hong Kong-traded Chinese Yuan (offshore market) had remained broadly in line with the official yuan (onshore) trading range. But market turmoil last Thursday and Friday prompted the Hong Kong price to slump at one point to a discount of as much as 2.5% to the mainland yuan, the biggest gap since China began relaxing its currency restrictions about a year ago.


The drop took place mostly in Hong Kong, a Chinese city that operates under its own set of laws and the only place where the yuan can be traded outside the Chinese mainland. Chinese officials over the past year have transformed the city into a laboratory for yuan liberalization, allowing everything from the issuance of yuan-denominated bonds to yuan-trade settlement to yuan accounts for individual investors.

The moves fly in the face of currency-market conventional wisdom, which holds that the yuan is set to rise against the U.S. dollar as China soaks up capital and trade flows. The surprising turn of events may evoke long-held fears in Beijing of financial turmoil among those wary of opening up the country's capital account. An entrenched fear in Beijing is that the international capital flows that built up Asian economies before laying them low in 1997, could do the same to China. That lies behind the complicated web of controls Beijing has built to control capital flowing in and out of the country.

China learned another lesson during the more recent global financial crisis. It found that a shortage of U.S. dollar credit globally affected its own export sector's ability to sell goods. Partly to fix that it decided the yuan need to be accepted internationally, and to make that happen it would need to open up its financial markets.

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