TODAY will be a historic day for Japan and China, although it is hardly one that is likely to be celebrated by singing and dancing in the streets of either of their capital cities. Instead, it will be marked by the start of direct, cross-currency trading between the yen and the yuan in Tokyo and in Shanghai.

No sooner the word than the deed, it seems, when it comes to verbal agreements between Japanese Prime Minister Yoshihiko Noda and Chinese Premier Wen Jiabao and follow-up action on their part. So fast, in fact, have they moved to implement cross-currency trading that markets have been taken by surprise.

A little-publicised agreement last December by the two leaders (little publicised because it was reached on Christmas Day when half the world was on holiday) to begin cross-currency trading and mutual government bond purchasing has borne fruit faster than most people expected.

Why the apparent rush to get things done on financial issues when in other areas - such as establishing a "hot line" between Japanese and Chinese leaders to prevent maritime and other clashes between the two countries - things have dragged on for many months if not years?

True, neither Mr Noda nor Mr Wen are likely to be around much longer in their current positions. Mr Wen will step down in a scheduled leadership change in Beijing later this year while Mr Noda may not pass the one year that Japanese prime ministers seem to last for nowadays. Both too have a keen interest in currency issues - Mr Noda because he was finance minister and Mr Wen because he is clearly on the side of the "reformers" when it comes to financial matters. But there is more to the agreement than just these things.

I happen to be one of relatively few people who believe that China-Japan financial cooperation will progress much faster than conventional wisdom suggests, and also that China will quite soon dismantle capital controls to give the yuan a bigger role on the international stage.

The launch of cross-currency trading between yen and yuan (in the Tokyo interbank market and in a specially designated market in Shanghai) is one clear sign of this. For China, it is designed to bolster the yuan's role as a regional and global currency, and for Japan to prevent the yen's eclipse.

Given the size of mutual trading now between the world's second (China) and third (Japan) largest economies - two-way trade was worth 27.5 trillion yen (S$448.8 billion) last year - it makes little commercial sense for almost all that to be settled in dollars than in yen or yuan.

By being able to exchange one currency for another (instead of having to go via the dollar "cross rate"), traders avoid double commissions and minimise the exchange rate risks inherent in having to do a double swap. But do Japanese exporters (China is their biggest single market) want to accept yuan rather than dollars - and what do they do with those yuan even if they do accept them? There is no US-style Treasuries market in China, and there are few other places to park yuan outside of Hong Kong banks.

The Wen-Noda agreement gave clues as to how things could change on this front. The Japanese government is taking the lead by deciding to purchase - with Beijing's consent, of course - Chinese sovereign debt up to around US$10 billion, and that could lead to Japanese private purchases too. Japanese financial institutions may also begin accepting yuan deposits, on which Japanese exporters could earn interest. But more important is the fact that the launch of yen-yuan direct trading is likely to encourage other countries in and beyond Asia to follow suit.

At that point, the yuan would begin to gain the kind of general acceptability that makes it a viable currency for financing transactions in general. Some countries in Asia and other regions are already accepting payment in yuan.

Where many commentators go wrong, in my view, in assuming that China will resist the kind of exchange control liberalisation that will need to accompany this process is in overestimating Beijing's desire to prevent yuan appreciation and to maintain strict control over the domestic money supply. China's accelerating shift from an export-dependent to a more consumer-oriented economy presupposes some appreciation of the exchange rate (which also helps dampen inflation) while the domestic money supply in China has already blown out significantly even without the help of free capital inflows.

Most important of all perhaps, is the failure by some to appreciate the strength of China's desire to curb what it sees as US dollar hegemony and to establish the yuan as an alternative reserve and transaction currency. The eclipse of the euro has only increased this desire.

Japan has seen the greatness of the yen come and go. The most it can hope for now is to see its currency carried along in the wake of the yuan tide rather than be swamped by it. That is why today should be seen as a big day for both currencies in and beyond the forex market.

ANTHONY ROWLEY

Tokyo Correspondent