The Chinese economy has been a huge success 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 – after only the United States and the European Union
However, China’s currency – the renminbi – accounts for only 3% of world trade. Compare that to the 87% market share of the US dollar. Despite its economic and political power, the country does not dominate the global flow of fiat currencies. Now, she’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.
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How do you check reserve status?
Achieving reserve currency status is not a formal process. Instead, it’s like winning a popularity contest.
The most popular currency for global trade and cross-border trade appears as a de facto reserve currency. The “popularity” of a currency simply depends on the perception of security and flexibility in the country of issue. This is the asset or currency that most central banks around the world prefer to keep in reserve, which is why the dominant asset earns the designation of “reserve currency”.
Since 1450, there have been six major currency reserve periods. Portugal dominated the world’s reserves until 1530 when Spain became stronger. Coins issued by the Netherlands and France dominated world trade for most of the 17th and 18th centuries. But the rise of the British Empire made the pound sterling the reserve currency until the end of World War I.
The US dollar displaced the British pound just as America gained economic superiority over Britain. More than 75% of global transactions have been conducted in US dollars since 2008. The dollar also accounts for more than 60% of foreign debt issuance and 59% of global central bank reserves.
Although the dollar’s grip on all of these markets and instruments has been gradually declining in recent years, no other currency comes close to these levels. To be sure, the Chinese renminbi is not a viable alternative, but geopolitical and macroeconomic trends support its rise to dominance.
This year, Chinese leaders have made clear that they want to strengthen the image of the renminbi as a reserve currency. China’s economy and trade flows are large enough to support such a move. However, the country now needs to 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 cooperation with five countries and the Bank for International Settlements to achieve this. China, Indonesia, Malaysia, Hong Kong, Singapore and Chile will contribute 15 billion yuan, or about $2.2 billion, to the renminbi liquidity arrangement.
Meanwhile, the Chinese yuan has already become Russia’s de facto reserve currency. The Russian leadership has turned to China after it faced sanctions from the West over its invasion of Ukraine earlier this year. Now, 17% of Russia’s foreign reserves are denominated in yuan. The yuan is also the third most sought-after currency on the Moscow Stock Exchange.
As these partnerships become stronger, the yuan’s position as a reserve currency can be solidified.
Economists, including Barry Eichengreen of the University of California Berkeley and Camille Macaire of the Central Bank of France, have published a paper analyzing the yuan’s potential as a reserve currency. The researchers argue that replacing the dollar will not be easy or quick. However, they found evidence that the yuan’s reserves are steadily increasing in countries that have stronger trade ties with China.
This increased influence could make the yuan an alternative to the US dollar in a “multipolar” world. In other words, China may get rid of the influence of the dollar over time. The study authors said that the current situation of the renminbi was similar to the US dollar in the 1950s. Based on this comment, it may only be a few decades before the yuan gains parity.
If the forecast is correct, long-term investors should consider some exposure to yuan-denominated assets and Chinese stocks with large yuan dividends.
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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.