China’s economy has been extremely successful by most measures. Its gross domestic product (GDP) of $17.7 trillion is second only to the United States. It is also the third largest trading country in the world – behind only the US and the EU
However, China’s currency – the renminbi – accounts for only 3% of global trade. Compare that to the US dollar’s 87% market share. Despite its economic and political power, the country does not dominate the global flow of fiat currency. Now, he’s looking to change that.
Here is China’s multi-trillion, multi-decade plan to replace the US dollar as the world’s reserve currency.
How do currencies gain reserve status?
Obtaining reserve currency status is not a formal process. Instead, it’s like winning a popularity contest.
The most popular currency for global and cross-border trade is emerging as the de facto reserve currency. The “popularity” of a currency is simply based on the perception of the safety and durability of the issuing country. This is the asset or currency that most central banks around the world prefer to hold in reserve, which is why the dominant asset earns the label “reserve currency”.
Since 1450, there have been six major periods of reserve coins. Portugal dominated world supplies until 1530 when Spain became stronger. Coins issued by Holland and France dominated world trade for much of the 17th and 18th centuries. But the emergence of the British Empire made the pound sterling a reserve currency until the end of the First World War.
The US dollar displaced the pound just as America gained economic supremacy over Britain. More than 75% of global transactions have been completed in US dollars since 2008. The dollar also accounts for more than 60% of external debt issuance and 59% of global central bank reserves.
Although the dollar’s hold on all these markets and media has been gradually diminishing in recent years, no other currency comes close to these levels. The Chinese renminbi is certainly not a viable alternative, but geopolitical and macroeconomic trends support its rise to dominance.
This year, Chinese leaders made it clear that they wanted to boost the renminbi’s profile as a reserve currency. China’s economy and trade flows are large enough to support such a move. However, the country must now convince foreign central bankers to start holding the Chinese yuan (the main unit of the renminbi) as a reserve.
In July, the People’s Bank of China announced a partnership with five countries and the Bank for International Settlements to achieve this. China, along with Indonesia, Malaysia, Hong Kong, Singapore and Chile will each contribute 15 billion yuan, about $2.2 billion, to the Renminbi Liquidity Arrangement.
Meanwhile, the Chinese yuan has already become a de facto reserve currency in Russia. The Russian leadership turned to China after facing Western sanctions over its invasion of Ukraine earlier this year. Now, 17% of Russia’s foreign exchange reserves are denominated in yuan. The yuan is also the third most in-demand currency on the Moscow Stock Exchange.
As these partnerships become stronger, the yuan’s position as a reserve currency could be further consolidated.
The global impact
Economists such as Barry Eichengreen of the University of California at Berkeley and Camille Macaire of the central bank of France published a paper analyzing the yuan’s potential as a reserve currency. Researchers argue that replacing the dollar will not be easy or quick. However, they found evidence that yuan reserves rose steadily in countries that had closer trade relations with China.
This growing influence could make the yuan an alternative to the US dollar in a “multipolar” world. In other words, China may eliminate the influence of the dollar over time. The study’s authors said the current position of the renminbi was similar to the US dollar in the 1950s. Based on that comment, it could be just a few decades before the yuan gains parity.
If the forecasts are correct, long-term investors should consider some exposure to yuan-denominated assets and Chinese stocks with significant yuan gains.
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This article provides information only and should not be construed as advice. Provided without warranty of any kind.