What's the greatest opportunity for the City right now? Russian initial public offerings? Investing in emerging markets? Both have their place, but the really big opportunity is getting relatively little attention: becoming the offshore trading centre for China's currency, the yuan.
The yuan is fast emerging as a credible alternative reserve currency to the dollar. As that happens, offshore markets for trading and investing all that money will emerge. The City should be able to become the main European yuan hub and possibly the global hub as well. But it has a fight on its hands. The Germans are already eyeing the market. So are the Swiss, and no doubt the French will try to muscle in. If the City wants it, it will have to fend off the competition.
China's huge population and rapid growth means it is well on the way to becoming the world's biggest economy. Its vast reserves which have to be re-invested around the world currently amount to $3.4trn, around double the entire GDP of America. And they are getting bigger every year. So it is likely that the yuan will soon be a major global currency.
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As Joachim Nagel of the Bundesbank, the German central bank, noted in a speech last week, the yuan resembles the deutschmark of the 1960s and 1970s. Rapid growth and huge trade surpluses saw the old German currency become a big part of the global financial system. The yuan is going through the same process, on a far larger scale. Whether it ever overtakes the dollar remains to be seen. But it will certainly become a lot more important, despite China's recent woes.
From virtually nothing three years ago, 12% of trade with China is now paid for in yuan. Australia and China agreed this year to allow direct convertibility between the two currencies, bypassing the dollar. The Japanese have done the same. Inevitably, there will be offshore trading centres such as Hong Kong where deals struck in yuan are settled, reserves stacked up in banks, and yuan bonds and other financial instruments are issued. Already 4% of yuan trades are cleared in Singapore and London. Asthe currency rises in importance, the value of that business will explode dramatically.
The City has a long history of developing markets in a range of different global currencies. After all, it created the euro-dollar market 50 years ago. The huge growth in trading and investing dollars for the rest of the world was one of the key drivers of the growth that made London the world's top financial centre by the 1990s and generated enormous wealth for itself and for Britain's economy.
But it can't take the yuan trade for granted. The City has a depth of expertise and trading savvy, along with a secure legal system, that other centres will find hard to match. But they won't necessarily be enough. Nagel's speech last week was aimed at staking a claim for Frankfurt as the natural European centre for the yuan trade. The Swiss are moving in too: Zurich would be as natural a home for the yuan trade as London. The French government is too busy dreaming up wheezes like taxes on smartphones and lowering the retirement age to worry about financial competitiveness but if it ever gets its act together it could make a play for it too.
None of these rivals should be written off. Germany does a lot more trade with China than Britain does. It is the third-largest exporter to the country the Chinese industrial revolution is largely powered by German machine tools. Germany is one of the largest foreign investors in China, and China is the largest foreign investor in Germany. Some German commentators now talk about the special relationship' between Germany and China, mirroring the relationship between Britain and the US. Frankfurt may not be able to match the City for the depth of its markets, but it is a very well-established financial centre and the Chinese are comfortable doing business there.
Likewise, the Swiss have lower taxes, are not restricted by the rules imposed by Brussels, and have a wealth of experience of trading internationally. European cities aren't the only potential rivals. New York will be an offshore centre for the yuan trade, as will Singapore and Dubai. It's likely, however, that one centre will dominate, just as London did with euro-dollars. The City has the skills and the expertise to capture that market and if it could make itself the global yuan centre it could easily sustain another decade or two of growth, just as the euro-dollar market did.
But to make it happen, London will have to make sure that it welcomes the Chinese currency, that it encourages firms and investors to trade in yuan rather than dollars, and that it worries as much about creating new businesses as it does about regulating existing ones. Mark Carney, the new governor of the Bank of England, has plenty on his plate with sorting out the British economy. But if he wants to ensure the long-term prosperity of the City as he certainly should then he should devote some of his energy to making sure the yuan trade gravitates towards London and not Frankfurt or Zurich.
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