What do the Roman denari, Venetian
ducato, Dutch guilder and US dollar have in common?
At one point in time they
have each been a “world (or reserve) currency.” The denari was the world
currency for more than 4 centuries during the Roman Empire’s prime, as was the
Venetian ducato during much of the Renaissance. The Dutch guilder emerged as a de
facto world currency in the 18th century due to unprecedented domination of
trade by the Dutch East India Company during a previous age of globalization. After
WWII, the US dollar assumed prominence – and continues to lead – in the world
of international trade, finance, securities and foreign exchange reserves. The dollar
has been the world’s most important reserve currency for over 50 years. That almost
seems like forever, until you remember the span of the denari; they don’t make
‘em like they used to. The final reserve currency now is the euro, born on Jan
1, 1999. It is used in the world’s largest economic assembly of nations and has
become a key reserve currency as well. In a large sense, these reserve
currencies make international trade and finance happen.
The dollar and euro together
account for 84.3% of the
world’s foreign exchange reserves. These reserves, which total $11.6 trillion,
are funds that nations’ central banks hold as assets to manage the value of
their currencies. The dollar accounted for nearly 90% of the
$5.3 trillion a day in foreign-exchange transactions last year.
Earlier this month, the
International Monetary Fund (IMF) said it will be adding the Chinese yuan (also
called the renminbi) to its special drawing rights (SDR) basket of reserve currencies,
which already contains the dollar, euro, British pound, and Japanese yen.
Adding the yuan will acknowledge China’s impressive growth and economic standing;
its nominal GDP is the second-largest in the world.[1]
Nevertheless, the yuan is not
a world reserve currency in any substantive way. To be considered for IMF
reserve currency status, a currency must be freely useable in foreign commerce.
The yuan is used in less than 1% of world’s foreign exchange trades and
international debt securities (e.g., bonds). To date, the Chinese have
seemingly created more island territory in the South China Sea than
international bond sales. Thus, the IMFs SDR decision probably has more to do
with geopolitics than economics. It also assuages the Chinese and other
emerging nations’ interests at the IMF because the US Congress has yet to pass
(after 5 years) legislation needed to change the fund’s governance structure giving
these nations more authority.
If it wants it to become a
genuine reserve currency, the Chinese government will have to make some very knotty
decisions regarding availability and stability of the yuan. Fundamentally the
government will have to relax its total control over Chinese domestic financial
markets and the yuan – something that it has shown no interest in doing so far.
One needed modification will
be to increase its availability outside China and begin issuing
yuan-denominated bonds and ETFs for international purchase. This year only 0.6%
of international debt securities outstanding were denominated in yuan
(virtually all in Asia), compared with 43% in dollars and 39% in euros. The
Chinese took a small step last week by opening an exchange in Germany to trade
yuan-denominated financial instruments. Nevertheless, few financiers are
booking flights to Frankfurt.
In addition, international
investors won’t be that interested in buying yuan bonds or ETFs unless they
believe the yuan will be relatively stable and orderly. Recent events regarding
the yuan have increased transnational concerns about its steadiness. Stability
was not enhanced when in mid-August the People’s Bank of China (PBoC, its central
bank) devalued the yuan by over 3% without any warnings. The PBoC remains cloaked
in opacity regarding its possible monetary plans. Perhaps Zhou Xiaochuan, the head of the PBoC,
could benefit from Janet Yellen providing him with a few pointers about more transparent
monetary policy. Furthermore, these changes may lead to a significant reduction
in China’s current-account (trade) surplus because international demand for
yuan bonds will increase the value of its currency. That’s hardly what the
Chinese would look forward to, given its success in creating substantial export-led
growth for its economy.
The yuan’s future as a
reserve currency will take a marathon’s worth of changes on the part of the
Chinese government. With changed policies and time, they may make it to yuan
world. The Chinese are out of the starting blocks but at a trifling pace.
[1] China’s GDP growth has indeed been impressive; however,
the Chinese per capita GDP is US$12,900 (ranked 113st in the world)
and nearly $32,000 less than the US GDP/capita.
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