The yuan is catching up to the dollar as an international currency. It’s a latecomer to the game, but it can quickly leverage its presence in the global market. Billionaire investor Ray Dalio believes the yuan will replace the greenback as the world’s premier reserve currency. The key is China’s effort to digitalize the yuan.
Yuan Is A Global Currency
Although yuan trading abroad has increased substantially, it is not yet enough to dethrone the dollar. Only about 2 percent of global import and export contracts are now denominated or settled in Yuan Global. This figure got an extra fillip in recent months because of Western sanctions against Russia, but it still falls well short of the proportion of global currency trading conducted in euros or Japan’s yen.
To snatch the dollar’s crown, China will need to achieve much greater progress in its internationalization goals, particularly as a store of value. It will also need to transform itself into a genuine rule-of-law state that provides the confidence and incentives for global capital to flow there. This will not happen overnight, but it can occur in a gradual process that results in the dollar’s decline rather than collapse. This will provide China with a more powerful leverage in global finance and trade negotiations. It will also help the country offset the adverse effects of a global slowdown.
Yuan Is A Global Asset
The yuan is rapidly growing its role as an international asset. It is becoming a currency of choice for trade and investment within the Asian economy, and is even beginning to compete with the dollar as a global reserve currency. However, China’s capital controls and limited transparency in financial markets limit the yuan’s progress as a global store of value and unit of account. Moreover, the USD is still the dominant currency in international payments.
The yuan’s share of global payments is growing, but from a much lower base than the euro and sterling. It is also a far smaller component of global reserves – less than 3%, compared to 58% for the dollar and 27% for the euro. Any international reserve currency needs to be supported by deep and accessible financial markets that can offer a wide range of investments, including short-term deposits, longer-term bonds, and stocks. And as far as global investments go, there are none better than US dollar-denominated assets.
Yuan Is A Global Investment
As China becomes a global economic powerhouse, investors are increasingly looking to gain exposure to its economy and currency. Currently, there are several options to do so, including purchasing Chinese government bonds, investing in funds that hold yuan and trading yuan futures. Nevertheless, the Yuan Global is still a long way away from attaining international reserve status. Beijing’s tight grip on capital flows, a lack of deep and transparent financial markets and a weak global reputation for credit risk mean it will struggle to become the world’s new reserve currency until it relaxes its rules and allows greater investment freedom both in and out of the country.
China is making progress with opening up its financial system and yuan internationalization has gained traction as a result of these initiatives. The launch of yuan options on the CME reflects this trend, and could further boost the currency’s influence in the years to come. Offshore yuan assets already account for around 25% of all global dollar funding and 20% of euro-denominated loans and deposits, according to research from ING.
Yuan Is A Global Market
Although a growing number of countries have adopted the yuan, it has not displaced the dollar as the world’s main reserve currency. “The yuan still has a long way to go,” says Natixis’ Garcia Herrero. “Until it becomes a global market currency, it will only be able to compete with the USD.” For China’s yuan to become globally accepted as a reserve and trade currency, it must fulfill three key functions: a valuation function (to settle transactions on transaction demand); a payment function; and a store of value function as a backup for international central banks and private investors. It also needs deep and transparent financial markets that offer a variety of investment opportunities, like stocks, bonds, options, futures and other derivatives.
China has been trying to improve the yuan’s standing by signing currency swap agreements with many countries, including Russia and Europe. But its efforts may not help the yuan challenge the dollar, according to ING. Its share of global payments through the SWIFT system climbed to 3% in July, but it still lags behind second-tier currencies such as the pound.
Conclusion
The yuan is slowly taking share of global trade, currency trading and even central bank reserves. But it will take a long time for China’s currency to challenge the dollar. China’s capital controls and limited financial markets mean it still has a way to go before its currency can rival the greenback.
