It is being mused and tentatively discussed amongst bystanders and participants of worldwide foreign exchange markets that the Chinese Yuan has the potential of soon replacing the US Dollar as the world’s reserve currency. For all the troubles two of the world’s leading currencies, the US Dollar (USD) and the Euro (EUR) are going through however, it is difficult to see how this could happen within the foreseeable future.
What lends a currency strength and value is trust. It follows that the world’s leading currency needs to be the one with the most trust in it. China’s lack of transparency regarding its own currency, let alone its foreign reserve operations, will not provide a foundation for such trust. Trust would be undermined further from other areas, such as political stability and rule of law that have yet to develop before reaching the more sustainable state seen in parts of the developed world.
Additionally, the existing exchange controls China has in place is one reason, they are massive. Although some loosening up has taken place, a liquid and open market is unlikely to be achieved at any point in the next 10 years. The government seems to be in no rush of loosening up its fixed system. This is partly the reason why 74% of respondents recently said no when asked by the Economist if they believed the Yuan would be the world’s main reserve currency in 10 years (source below).
Additionally, the existing exchange controls China has in place is one reason, they are massive. Although some loosening up has taken place, a liquid and open market is unlikely to be achieved at any point in the next 10 years. The government seems to be in no rush of loosening up its fixed system. This is partly the reason why 74% of respondents recently said no when asked by the Economist if they believed the Yuan would be the world’s main reserve currency in 10 years (source below).
One reason often cited as the reason for impending world’s reserve status is the size of the country’s economy. However, this is an abstract factor regarding currencies that has no direct impact. Switzerland's economy for example amounts to just 8% of Japan's, yet the Swiss franc (CHF), as a reserve currency, achieves a market share almost as big as that of the yen. What is far more important are sophisticated financial markets readily accessible for investors, such as liquid bond markets. This is currently not to be found in China.
Looking at America, the downgrade from AAA to AA (see blog post below) caused frightened investors to paradoxically seek out Treasury bills in search for safety. This shows the true extent to which the world still looks to and believes in the USD as the leading reserve currency. No downgrade of another nation would have investors fleeing for that country’s securities.
Further Reading:
http://www.economist.com/debate/overview/213
http://www.economist.com/debate/overview/213
I do agree with them that the Yan is not gonna a be the world's reserve currency in 20 years. Western countries are against giving too much power to China so they are going to do everything in their way to stop it.
ReplyDeleteI think a currency basket would be a good option but do you think US would like to participate with China in something like that?
I also agree that Western nations want to avoid it at all costs and I agree that the element of trust will be a determining factor and I strongly believe that topics such as Human rights and the large number of people, particularly in rural areas, who, are still very much living in poverty.
ReplyDeleteThe media is very good at giving a glorified version of China and though it is true that people are benefiting from the country's development, it is very specific to the major cities and coastal areas, no where else. Some very interesting books and reports have come out about the amount of overseas Chinese workers delevoping African rural areas, building roads and installing communications networks such as telephones. Yet the families of these workers living in rural areas remain without all of these amenities.
Until this improves, I think trust in the currency will be limited.
Financial blog, as of yet I do not believe the US would be willing to co-operate with China in a currency basket. It would be pyschologically difficult for Americans and a political impossibility. Co-operation with Europe and the Euro is more likely for the time being. However, as stated in the original post, in 10-20 years this could change and I don't think anyone can forecast at present if US and Chinese co-operation in future can already be completely ruled out.
ReplyDeleteHeleneg, thank you for your valuable insight.