The yuan’s growing use to settle international trade deals shows the global currency is on its way to becoming an international force. But does this mean the dollar’s dominance is over? China has pursued yuan internationalization as it seeks the benefits that come with it, including greater business for Chinese banks.
The History Of The Yuan
The Yuan dynasty produced many art treasures including the first metal tubular shooting weapon – a blunderbuss. It also developed the art of printing, resulting in the iconic Chinese blue and white porcelain jars and novels like Romance of the Three Kingdoms and Water Margin. The Yuan International promoted international trade through several means, including granting artisans a more elevated status and tax exemptions and reducing the costs of loans to merchants. It also established a system of currency exchanges, roads and canals that made the movement of goods easier.
Today, the yuan falls woefully short of having all of the attributes of an international reserve currency. The main problem is that it cannot fulfill all three major functions of a world reserve currency: a valuation function, to settle trade based on transaction demand; a payment function, to facilitate the settlement of transactions; and a storage function. This limits its value as a reserve currency. In addition, China’s onshore and offshore rate system imposes significant trading costs.
The Future Of The Yuan
As China grows as a trading economy, the yuan is gradually growing in importance as a world currency. It is already the fifth-largest payment currency, a third-largest trade financing currency, and an international reserve currency. It has also gained in popularity as a global settlement currency. As of 2022, 42.1 trillion yuan worth of cross-border payments and receipts were settled in yuan. In addition, a growing number of major oil exporters are willing to accept yuan for oil deliveries. And a few major global financial institutions have established yuan clearing banks.
However, the yuan is still not fully internationalized. It is still only used for a small percentage of global import and export contracts, and the country’s onshore and offshore rates are separate (CNY and CNH). Moreover, the yuan remains heavily tied to the dollar in terms of foreign exchange reserves and the size of its global market share. As a result, it is unlikely that the yuan will replace the USD as the dominant world currency anytime soon.
The Yuan’s Influence On The Global Economy
The yuan has been rising as a global trade and investment currency for several years. However, the pace of its internationalization has accelerated significantly since the beginning of the conflict in Ukraine. Beijing has encouraged foreign companies to settle their exports and imports in yuan and opened up its financial markets to overseas investors. The yuan is now used to buy and sell commodities, as well as for cross-border payments. It is also becoming increasingly used as a reserve currency by emerging economies. The yuan has many advantages for both China and its trading partners, including lower transaction costs and the diversification of foreign-exchange reserves.
Yet the Chinese authorities’ need to control capital flows will likely make it difficult for the yuan to become fully internationalized and challenge the dollar’s dominance. Unless this changes, it is unlikely that the yuan will ever be the dominant international currency. Instead, it is more likely that other currencies will replace the dollar.
The Yuan’s Impact On The Global Financial Markets
The Yuan International impact on the global financial markets will likely grow as it continues its internationalization. While China’s financial markets and monetary regime remain heavily restricted, the increasing use of yuan for cross-border settlements could reduce transaction costs for companies and reduce the need to maintain large foreign-currency reserves.
China is pushing to promote the yuan in its trading partners. It is encouraging its banks to lend overseas, and has signed bilateral agreements to enable trade financing in yuan with countries including Argentina, Brazil, Russia and Saudi Arabia. It has also set up a commodity exchange in Shanghai that trades in the currency, and is expanding yuan clearing banks. However, as long as Beijing remains comfortable using capital controls to prevent outflows of yuan-denominated assets, the yuan will struggle to dethrone the dollar. This will be especially true if the US Federal Reserve raises interest rates, which would further reduce its global appeal as a safe asset.
Conclusion
As the US loses dominance as a global monetary power, some nations are pursuing alternatives. Russia has sought to increase reserves in yuan and gold, for example. Meanwhile, China is stepping up efforts to make it easier for foreign countries to settle trade in yuan. These moves come amid growing geopolitical tensions.
