Can the yuan be a key global reserve currency?
The yuan, or renminbi, China’s monetary unit, has been touted as a contender to become a key global reserve currency on par with the greenback and outperforming the euro, yen and pound sterling. But is it doable?
Given that China is the biggest trading nation, with around 125 countries considering it their biggest trading partner, the answer is probably yes.
China’s trade was valued at around US$6 trillion in 2021, according to the country’s General Administration of Customs. If China and its trading partners agreed to use their respective currencies for bilateral transactions, the demand for the yuan would be astronomical. This would accelerate the yuan to become a key global reserve currency.
Indeed, the fact that the yuan is a major world currency or that it serves as an alternative to the greenback is not necessarily a bad thing. Trading partners using each other’s currencies for investment settlements and other interactions would reduce transaction costs, minimize exchange rate volatility and circumvent US sanctions, for example.
Effect of US sanctions
Sanctions against nations deemed “hostile” to the United States have had a devastating effect not only on the targeted countries, but also on global economies, including ironically that of the United States. The latest example is the United States and its European and Asian allies sanctioning Russia for invading Ukraine.
Read also: Russia’s attack on the dollar more insurrection than war
The harsh sanctions not only cripple the Russian economy, but also harm other economies, including those that have themselves sanctioned Russia. Oil and food prices have soared, threatening a global recession.
In the United States and Western Europe, many families make difficult choices between eating and warming up, for example. Although Western economies are growing, the number of poor and homeless people has increased, suggesting that growth is not evenly distributed.
Yuan as a medium of exchange
It may be because of the impact of US sanctions on their own economies that some countries are abandoning the US dollar and accepting the yuan in trade settlements. More recently, Saudi Arabia is said to be finalizing an agreement with China to settle oil transactions in yuan.
It’s also worth noting that around 70 central banks around the world held the yuan in their foreign reserve portfolios in 2019, according to the People’s Bank of China (PBOC), the country’s central bank. This number is sure to increase as the Chinese economy continues to grow. Another factor pushing countries to hold the yuan is the fear of being the next target of US sanctions.
Challenges for the yuan as a global currency
However, some would say that the internationalization of the yuan to the extent of that of the greenback will be difficult, mainly due to China’s governance and development architectures. The one-party rule, the lack of universal suffrage and the lack of a mechanism for the orderly and peaceful transfer of power raise some concerns about China’s political stability.
Another challenge is that the yuan is not fully convertible, which poses a problem for cross-border remittances. And China’s economic development model is out of step with neoliberalism, including how the yuan is valued. For example, the PBOC applies administrative measures to determine the US-yuan exchange rate.
Political stability is important in determining the acceptance of a currency as it involves minimum political risk. For example, the US dollar.
The United States seems politically chaotic with the two main parties fighting each other, achieving nothing or creating divisions between ideological or racial groups. But its governance system of “checks and balances” – equal power between the executive, legislative and judicial branches – keeps everyone “honest”.
For example, the president can only implement policies that fall within the power granted to him by the constitution. And Congress controls the stock market, limiting the president’s power.
Simply put, there is no reason to believe that the US government will collapse anytime soon, regardless of its policies that might suggest otherwise. This is one of the reasons the US dollar will continue to be a safe haven for investors and savers around the world. The greenback has proven to be a good store of value.
So the question is: can China offer the same level of confidence for the yuan? Many in the West would say no.
But the Chinese Communist Party appears to be able to maintain and even increase its popularity with the Chinese population, garnering an approval rating of over 90%, as found by Harvard University. One of the main reasons for this high level of support is the resilience and adaptability of the CPC. In other words, the party has been constantly “reinventing” itself since the days of Mao Zedong, responding to the needs and desires of the people.
So if the party continues to evolve, it will probably be in power for a very long time. Indeed, it can even be argued that the CCP is one of the very few political parties in the world, including in the West, that actually fulfills its fiduciary duties.
For example, the CCP is committed to eradicating extreme poverty, and it has done so. In the West, governments talk about poverty alleviation or climate change, but have not ‘taken their cue’.
From this perspective, the CCP has shown that a one-party system can ensure political stability. In this sense, the yuan is an acceptable medium of exchange and storage of value, paving the way for it to become a global reserve currency.
Economic reform, currency convertibility
China takes a gradual approach in economic reforms and floats its currency freely to avoid costly policy mistakes and prevent external shocks.
In many ways, China is still on the learning curve when it comes to economic reforms, especially the transformation from its social market economy to a private market economy. Maintaining public enterprises and banks acted as an economic and social stabilizer as they provided affordable prices and prevented the collapse of the financial system.
It would be unwise to dismantle SOEs and SOEs without a clear and orderly mechanism for transformation. The privatization of state enterprises, for example, could drive up energy or transport costs. This, in turn, could lead to economic dislocation and social discontent.
As for not letting the yuan float freely, this is largely to support export growth and prevent foreign hedge funds from attacking the renminbi. A freely floating yuan could very well cause its value to appreciate, with China losing a price advantage.
An undervalued yuan would make it difficult to attack, especially when China has more than $3.25 trillion in foreign exchange reserves. Also, China’s international debt is less than $2 trillion, so it has more than enough to meet its external debt obligations.
Taking the analysis to its logical conclusion, the yuan as a reserve currency at par with the United States is a matter of when, not if.
Ken Moak has taught economic theory, public policy and globalization at the university level for 33 years. He co-wrote a book titled China’s economic rise and its global impact in 2015. Her second book, Developed countries and the economic impact of globalization, was published by Palgrave McMillan Springer.