China, as the second largest economy and the biggest export nation, is gaining more and more influence on the world market. Experts claim we could be at the edge of a revolution of the financial markets, having the yuan as the new global reserve currency.
After many discussions in our blog about the existence of a currency war, blaming especially China to devaluate its currency for competitive advantages, the article “Redback im voraus” in the Wirtschaftswoche #47 particularly caught my attention. It describes an ongoing internationalization process of China’s renminbi, or also called yuan, to reduce reliance on the dollar and even to become a global reserve currency.
And indeed a recent very interesting study from HSBC with the title “The rise of the redback – A guide to renminbi internationalization” supports this argumentation. “If there is to be a rival to the dollar as the world’s reserve currency in the 21st century, it must surely be the Chinese renminbi”, Qu Hongbin, chief China economist at HSBC sais. He further explains, “We expect at least half China’s trade flows with emerging markets to be settled in renminbi within three to five years, making it one of the top three global trading currencies.”
China has already taken some steps to encourage cross-border trade using the yuan by signing bilateral currency swaps with other nations, as illustrated in the Wirtschaftswoche. Countries like Malaysia or Argentina (see chart) exporting goods to China can be paid in yuan and in return purchase products from China using the Chinese currency.
Moreover, the Wirtschaftswoche outlines the enormous development of an off-shore market of the yuan in Hong Kong. After the Chinese government already eased restrictions, several Chinese and foreign institutions have increasingly issued yuan-denominated bonds.
Using the yuan instead of the U.S. dollar accelerated in part by the financial crisis and the weakness of the dollar, as investors as well as companies seek less risky alternatives to hold their reserves in.
Given China’s economic and trade power, I think it will increasingly be natural for the renminbi to become a reserve currency. However, the process to liberalize the markets could take several decades. Therefore, the yuan will rather gradually develop to an international currency.
And it must also be considered, if the Chinese government continues with liberalizing its currency the yuan will probably gain in value. This in return might be discouraging for China’s exports but, on the other hand, could release the tension between China, the USA and Europe on the currency valuation issue.
All in all, if and how fast the yuan develops to a global reserve currency depends on long-term political and economic development and until there is a political reform in China there can be no freely convertible currency.