The US Dollar is the world’s reserve currency and many bilateral trade agreements that involve currencies which cannot be immediately converted into one another are conducted via the Greenback. Inevitably, such transactions increase the costs associated with a project and its complexity. The Chinese currency is not fully interconvertible against other major currencies despite the fact that it is the currency used in the world’s second largest economy and therefore, Chinese goods are traded around the world.
The Chinese authorities and the European Central Bank have announced an initial three-year deal for a currency swap worth $57 billion. The agreement can be extended beyond three years if both parties agree. The deal means that bilateral trade between Eurozone businesses and China can be settled in local currencies (i.e. the Yuan and the Euro) and allows the partners to swap or borrow each other’s currencies at an agreed rate. According to the ECB, trade between the Eurozone and China was worth more than €10 billion in July.
The deal protects both parties from swings in the exchange rate, but it must be said that the Yuan is anchored against the Dollar anyway. A simple check on the data shows that for the year to date, the relative standard deviation of the Euro:Dollar exchange rate is 1.64% (average value 1€:1.3005$) whereas the Dollar:Yuan relative standard deviation is 0.72% (average value 1$:6.233 Yuan). Most analysts believe that the Yuan is a minimum of 20% below its true market value. An undervalued currency gives a nation an advantage in importing markets by effectively discounting the cost of its products.
China has entered into 22 currency swap agreements around the world with deals valued at 2.2 trillion Yuan (about 353 billion Dollars).
Commenting on the deal, China’s central bank said: "The new arrangement will provide more liquidity to the renminbi (Yuan) market in the euro area, promote overseas use of the yuan, and help facilitate trade and investment." For its part, the ECB noted: “The swap arrangement has been established in the context of rapidly growing bilateral trade and investment between the euro area and China, as well as the need to ensure the stability of financial markets."
Europe's central bank also said the deal would reassure eurozone banks of the continuous provision of Chinese yuan.